Most people assume their retirement accounts are protected from creditors, but depending on where you live, and the specific type of retirement account you have, this is not necessarily true.
Primarily, on the Federal level, a new court decision in 2021 has further clarified what has been an often-muddled area of law regarding which retirement accounts creditors can attack through bankruptcy.
Remembering the Basics
It is important to remember any ERISA retirement plan is protected. Most commonly, though, this includes your 401(k) plan, but also covers 403(b), 457(b) plans and most pension plans.
More simply, this likely covers any plan that you get through your work if you are not self-employed. Along those lines, any former ERISA plan that has been classified as an IRA rollover plan is also protected.
Note that the term “rollover” is important, because it does not mean all IRA accounts are protected. The courts have made a distinction between a rollover IRA – one that comes from, and originates from, your employer plan – and a traditional IRA that an individual sets up.
The former is fully protected, as it originated from an ERISA-protected plan, but the latter receives partial protection from creditors. The protection these non-rollover IRAs receives comes from the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, which extended full protection to SEP and Simple IRAs and gave partial creditor protection for other IRAs.
The maximum protected amount in 2021 is $1,362,800 across all traditional IRA accounts. Remember, rollover IRAs are fully protected, regardless of the value and these limitations only apply to non-rollover IRAs.
What About Inherited IRAs?
Are they protected? The answer is yes and no. While there has yet to be a direct court case confirming this, most experts agree that spouses who inherit rollover IRA accounts also receive all the same bankruptcy protections as their husband or wife enjoyed with those accounts.
Additionally, there have been some Supreme Court dicta stating such as well. “Dicta,” is a statement made by the court that isn’t necessarily relevant to the case its deciding, nor is it binding, but it does give some idea as to which way the court would lean if a case did come up on the subject. Therefore, spousal rollover IRA accounts are likely protected.
Beyond spouses, it had generally been believed that non-spousal inherited IRAs did not receive protections. But in a case earlier this year, a federal court surprised legal experts and extended protections to a 401(k)-account inherited by a non-spouse.
While the case did not cover it, this new ruling makes it likely that a future case would further expand protections to inherited rollover IRA accounts as well as a similar logic being used.
I will note this was a western district of North Carolina case, In Re: Dockins, for anyone that wants to look it up. The broader Supreme Court for a definitive opinion has not taken up the case, so while unlikely, it is possible another District Court could come to a different conclusion.
Inherited rollover IRA accounts are treated distinctly different from inherited traditional IRA accounts, the latter of which the Supreme Court has made clear are not protected from bankruptcy.
One other important specific situation in regards to retirement account protections: so far, courts have been treating all retirement assets that are split during a divorce proceeding as losing all bankruptcy protections for the party receiving those assets. The spouse whom the assets were originally in the name of does retain his or her protections.
Note that the scenarios we discussed here are in regards to federal bankruptcy protection. State laws generally govern other issues and situations regarding creditors and retirement accounts protections.
Luckily, for those of us living in Pennsylvania, the state offers a high degree of protections for all retirement type accounts, whereas, other states offer much less protection. If you would like to learn more about this, please let us know and we would be glad to help.