You can lose your assets to creditors (from whom you have borrowed), to divorce or paternity suits, to false claims against your pocketbooks, or to the government for taxes owed.
What you have in your IRA or other qualified plan has some asset protection. But federal and state laws together determine when and how much protection those assets actually have, and from whom. That’s what this article is about.
Protected Qualified Plans:
The Bankruptcy Abuse and Consumer Protection Act of 2005 (BABCPA) established protection limits for several qualified plans:
* SEP (Simplified Employee Pension) IRA, SIMPLE (Savings Incentive Matching Plan for Employees of Small Employers) IRA, and all defined benefit and defined contribution employer retirement plans have unlimited creditor protection in the event of bankruptcy. This includes 403(b), 457, and government or church plans under code section 414
* Distributions from all employer defined benefit and defined contribution retirement plans retain creditor protection if rolled over to an IRA
* Traditional and Roth IRAs not created from qualified plan rollovers are subject to creditors, but only to the extent these accounts exceed $1 million,
* Employee retirement plan protection (including SEPs and SIMPLE IRAs, and non-ERISA retirement plans such as individual 401(k)s) now receive unlimited creditor protection during bankruptcy, regardless of ERISA.
Keep good records of all your transfers from qualified plans and transfer them to separate IRAs to maintain your unlimited protection.
Also note that a qualified plan is not considered an ERISA plan if it covers only the business owner (owner-only plans). Check your state law to see how these plans are protected.
Federal protection, when and from whom Unfortunately, this protection comes into play under bankruptcy, a federal process. The protection is from typical creditors (that is, those from whom you borrowed money).
Does not include protection against qualified domestic relations orders (in which assets may be awarded to your former spouse or other alternate payee). It also does not protect you from IRS tax liens.
Where your state law plays a role:
For all legal actions that do not involve bankruptcy, your state law will determine how much protection your qualified plan assets have. So check what your state offers you for your plan.
Two areas where state laws vary on protection are:
1. retirement plan,
2. plans inherited to the beneficiary
Most states will exempt all qualified plan assets, but only while they are in the retirement account. Some other states limit how much is exempt from creditor actions. This amount may be set, possibly at $500,000, or only limited to what is ‘reasonably necessary’ to support the owner and his dependents if a claim is made against those assets.
Unfortunately, ‘reasonably necessary’ is vague. It may depend on your age, other property you have, and your obligations. It depends on a court and it depends on the lawsuit filed against you. Vague terminology like “reasonably necessary” always invites lawsuits.
Because IRAs are vulnerable under state law, you may find it worse to transfer your company-sponsored plan to your own IRA for better control of your retirement investments. Your state may offer much less IRA protection from creditors than your company’s plan.
Again, your state may not protect your plan assets inherited by your beneficiary from your creditors after your death. Check with your state. You may want to set up a trust as the beneficiary of your retirement account for better protection. Of course you can benefit those people you designate in the trust document as beneficiaries.
Remember that the bottom line to successfully protecting assets is to recognize who you are protecting them from and then position those assets accordingly – a task easier said than done!