Are your retirement savings secure from creditors?
Estate planning and asset protection go hand-in-hand. After all, no matter how well your estate plan is designed, it won’t do much good if you have no wealth to share with your family.
If you have significant assets in employer-sponsored retirement plans or IRAs, it’s important to understand the extent to which those assets are protected against creditors’ claims and, if possible, to take steps to strengthen that protection.
Most qualified plans — such as pension, profit-sharing and 401(k) plans — are protected against creditors’ claims, both in and out of bankruptcy, by the Employee Retirement Income Security Act (ERISA). This protection also extends to 403(b) and 457 plans.
IRA-based employer plans — such as Simplified Employee Pension (SEP) plans and Savings Incentive Match Plans for Employees (SIMPLE) IRAs — are protected in bankruptcy. But there’s some uncertainty over whether they’re protected outside of bankruptcy.
The level of asset protection available for IRAs depends in part on whether the owner is involved in bankruptcy proceedings.
In a bankruptcy context, creditor protection is governed by federal law. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), both traditional and Roth IRAs are exempt from creditors’ claims up to an inflation-adjusted $1 million. The exemption through the first quarter of 2012 is $1,171,650; it’s scheduled to be adjusted on April 1, 2013.
The IRA limit doesn’t, however, apply to amounts rolled over from a qualified plan or a 403(b) or 457 plan — or to any earnings on those amounts. Suppose, for example, that you have $4 million invested in a 401(k) plan. If you roll it over into an IRA, the entire $4 million, plus all future earnings, will generally continue to be exempt from creditors’ claims in bankruptcy.
To ensure that rollover amounts are fully protected, it’s a good idea to keep those funds in separate IRAs rather than commingling them with any contributory IRAs you might own. Also, make sure the rollover is fully documented and the word “rollover” is part of its name. Bear in mind, too, that once a distribution is made from the IRA, it’s no longer protected.
Outside bankruptcy, the protection afforded an IRA depends on state law. Most states provide traditional and Roth IRAs with some protection against creditors’ claims, ranging from the amount needed for the owner’s support to a full exemption. It’s uncertain whether SEP plans or SIMPLE IRAs are protected outside of bankruptcy; there’s some precedent for the argument that state-law exemptions don’t apply to these IRAs.
What about inherited IRAs?
Federal courts are divided on whether bankruptcy protection extends to inherited IRAs. In a nonbankruptcy context, some states expressly exempt inherited IRAs, while courts in other states are divided on the issue.
To provide additional asset protection to your heirs, consider naming an IRA trust as beneficiary of your IRA. If the trust is designed properly, it will preserve the tax-deferral and other benefits of the IRA while offering greater asset protection to your beneficiaries than an inherited IRA.
If you’re concerned that your retirement savings are vulnerable to creditors’ claims, consult your estate planning advisor about asset protection strategies. The effectiveness of these strategies depends on factors such as whether future creditor claims arise in bankruptcy and what state law applies.