Many people know that IRAs and 401(k) plans have creditor protection. However, most people do not know the limits of that creditor protection. It may come as an unwelcome surprise, but if someone is suing you: (1) if you owe money to the IRS or to an ex-spouse, (2) if your retirement plan is of a certain type, or (3) if your beneficiaries are under creditor attack, your retirement funds may not be protected at all.
First, if you owe tax dollars to the IRS, or are late on alimony or child support payments, your retirement plan is almost never a safe haven. The IRS, an ex-spouse, and minor children act as “super creditor” against your retirement plans. Ex-spouses have an additional level of protection during the divorce process, as they can have retirement plans transferred directly to their own retirement plan using a Qualified Domestic Relations Order.
Second, the type of retirement plan that you have matters when it comes to creditor protection. Your 401(k), employer-related IRA, Roth contributory plans, traditional IRAs, and IRA rollovers from these types of plans ARE protected against most non-government creditors, such as credit card debts, medical debts, and mortgage defaults. In some cases the principal of these plans is even protected for Medicaid eligibility purposes. Even better, many of these plans are also exempted from state income tax deficiencies. However, if you are a federal or state employee with one of their government retirement plans (other than a 457 Plan), then these retirement funds are not protected from most creditors.
Third, an Inherited IRA, meaning an IRA transferred to you from someone other than your spouse when they died, is not protected from bankruptcy creditors, and is probably not protected from any government entity either (though the US Supreme Court has not ruled on the latter yet). Therefore, it is important to have your IRA distribute funds to a trust for the benefit of your spendthrift children and disabled beneficiaries to avoid the funds going to their creditors.
Remember that annuity contracts that are not in IRAs or other employer retirement plans are tricky and the law is unclear. For example, in New York there is a statute that states all annuity proceeds are protected from bankruptcy, yet simultaneously there are court cases stating the annuity may have to pay a portion of annuity installments to creditors depending on the owner’s financial position.
Before you assume your retirement plan is protected, make sure to do a lot of research before you put your assets at risk.
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