How safe are your clients’ savings? How retirement plan accounts are generally protected from creditors

If a client is unable to pay a debt, creditors may resort to legal action to get what they’re owed. If this action is successful, the consequences for a client can be devastating. A legal ruling in favor of a creditor may lead to seizure of a client’s assets and ruin his or her creditworthiness—potentially preventing borrowing for years to come. Bankruptcy, although a more orderly process than individual creditor lawsuits, can also leave a client with little more than what's needed to survive. Although several years of steady economic growth caused the total number of bankruptcies (personal and business) to decline through 2019, the potential for a tidal wave of new bankruptcies under current economic conditions is quickly becoming a concern.

Simply put, the incidence of financial hardship is sensitive to the state of the economy—it rises with unemployment. While some assets, such as a primary residence, are mostly out of creditors’ reach under different state laws, others, such as ordinary investment accounts, may be accessible.

Retirement accounts are different. Unlike other investment assets, they generally get special protection from creditors under federal law and, in some cases, state law; however, because not all retirement accounts are covered equally, the accessibility of  clients' assets to creditors depends on the type of account they’re in. 

The Employee Retirement Income Security Act (ERISA) keeps qualified plans and welfare benefits, such as health savings accounts, out of reach of creditors in most circumstances, mainly because of the anti-alienation clause, which states that your rights to the benefits can’t be taken away. 401(a) profit-sharing, 401(k), 403(b), nongovernmental 457, defined benefit, and SIMPLE 401(k) plans, as well as SIMPLE and SEP IRAs, are generally out of reach of creditors—with four exceptions:    

1   Payments awarded to a former spouse or other alternate payee under a qualified            domestic relations order

2   A lien imposed by the IRS for nonpayment of taxes

3   Federal criminal fines or penalties

4   Civil or criminal judgments for damage a participant caused to a retirement plan

Once assets are withdrawn from an ERISA-qualified plan, they lose the shield provided by this federal law. The one exception is assets in an IRA that consist of only qualified plan rollover money—those assets remain safeguarded from creditors, but protection is under federal bankruptcy law. 

IRAs are protected from creditors by federal bankruptcy law under the following circumstances:

• If the entire IRA balance came from a qualified plan rollover
• For an amount up to $1,362,800 (as of 2019 and indexed for inflation every three         years thereafter) for deductible and Roth IRA contributions and earnings on those         contributions; this amount doesn’t include employer plan rollovers  

Inherited IRAs—those received by a client as a beneficiary of an account—are not protected from seizure under federal law, although some states may offer protection.

State laws govern protection from creditors in IRAs, but they vary from state to state. IRA account holders should check with the state in which they reside to learn about specific creditor protections offered by their state.

Lawmakers at the federal and state levels recognize how important retirement plans are to the financial security of Americans and have, therefore, granted retirement plan assets many types of special treatment—including protection from creditors. ERISA-qualified plans are mostly safe from seizure, with limited exceptions. In cases of bankruptcy, IRAs funded exclusively with qualified rollover money and certain other IRA assets up to a specified dollar limit (as mentioned above) are also shielded from creditors. State laws may also offer some creditor protection. But once clients withdraw funds from an ERISA-qualified plan, their assets may become vulnerable to creditors, so be sure to talk to your clients about protecting their retirement plan assets before they take a withdrawal. And, if they have creditor worries, have them speak with an attorney.