Does Filing for Bankruptcy Affect Your Retirement Accounts? Thoughts on IRA’s, 401(k)’s, 403(b)’s, etc. with Estate Planning in Mind
It should be reassuring to know that most retirement accounts are protected in bankruptcy from seizure by the bankruptcy trustee because either they are not property of the bankruptcy estate or are exempt. If they are considered property of the estate, federal and state law typically provide exemptions to protect such accounts.
Congress created the Employee Retirement Income Security Act (ERISA), whereby virtually all retirement and pension plan funds are excluded from the bankruptcy estate, including 401k, 403b, 414, 567, Roth IRA, Keogh, profit sharing, money purchase plans and defined benefits plans. The reason is ERISA-qualified retirement accounts have certain transfer restrictions which protect them from creditors. These restrictions are enforceable in bankruptcy. The only limits to the broad rule involves traditional and Roth IRAs where the exemption is limited to $1,245,475.00 (as of the writing of this article) per person for all retirement plans combined. Most individuals are unlikely to surpass this amount. Further reassurance comes in the form of roll overs. If you were laid off or changed jobs and rolled over your 401(k), for example, into an IRA, 100% of the account balance is protected in bankruptcy.
If you have retirement accounts exceeding the threshold amount, the law provides investors an incentive to keep IRAs funded with rollover salary deferral contributions separate from IRAs funded with annual contributions as the former has unlimited protections and the latter only limited.
The Bankruptcy Abuse Protection and Consumer Protection Act (BAPCPA), which made several substantial changes to the Bankruptcy Code in 2005, reinforced the fact that IRA assets from rollover of employer funded IRAs are protected without limit as are any rollover distributions. It does not, however, protect required minimum distributions. BAPCPA also added small businesses and self-employed retirement vehicles to the list of exceptions, including SEP-IRAs, Simple IRAs and Keoghs.
It is important to remember that funds withdrawn from retirement plans lose their protection, unless rolled over within 60 days into other IRA or retirement accounts. Once any portion of retirement funds are taken out prior to filing for bankruptcy, that portion is no longer off limits to the trustee. An inherited IRA is not considered a retirement account and is therefore not protected, except if inherited by a spouse and rolled over into the spouse’s IRA. But if it is not rolled over, it is considered an inheritance and therefore unprotected.
As previously mentioned, not all plans qualify for bankruptcy protection. Those that do not include the following:
- Employee stock purchase
- Improperly funded plans
- Plans not qualified as retirement plans under the tax code
- IRA inherited by someone other than a spouse
- Plans rolled over or transferred into a new fund not in compliance with the tax code
- Plans not receiving favorable determination by IRS
Before deciding to liquidate your retirement account to pay off debts, talk to a Montgomery County bankruptcy attorney to determine if you have other options. You may be able to eliminate your debts AND keep your retirement funds.