“If you think that personal bankruptcy is a real possibility in your future, understanding IRA bankruptcy protection can potentially save a significant portion of your net worth, as well as unnecessary taxation from premature distributions.”
There are some protections in place for IRAs in the face of bankruptcy, says The Balance in the article “What is IRA Bankruptcy Protection?” The protection from the federal government extends to personal IRAs and Roth IRAs, but there are some limitations.
President George W. Bush signed bankruptcy protection into law in 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCA). This new law insulated retirement accounts from creditors, by providing that contributions to various retirement plans were excluded from the property of the estate. This was the first time that protection for individual retirement accounts existed.
Today, IRA bankruptcy protection includes all the retirement accounts: traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs and rollover IRAs. Protection is limited by the amount, which increases on a regular basis.
Here’s a look at the IRA bankruptcy protection from BAPCA:
Traditional IRAs and Roth IRAs: The most recent adjustment was in 2016, when the protection limit was increased to $1,283,025.
SEP IRAs and SIMPLE IRAs: These IRAs receive the same protection limits as traditional and Roth IRAs. They are used by self-employed people and small businesses.
Rollover IRAs: These are traditional and Roth IRAs that were funded by rollover transfers from an employer-sponsored retirement plan, like a traditional 401(k) or a Roth 401(k).
These protections are considered to be high enough to cover most Americans’ IRA accounts. There are some assets that are not protected. Some examples include general creditors, IRS levies and divorce.
General Creditors: There’s no federal protection for IRA owners, and the protection from general creditors varies by state law.
IRA Assets and IRS Levy: If you owe past taxes to the IRS, they can levy your pay and your IRA. They’ll generally go after other assets first, but if necessary, your IRA is fair game.
IRA Assets and Divorce: What happens to your IRA in a divorce depends upon a court order and other assets that are held. If IRA assets are divided, taxes can be avoided. According to the “incident to divorce” rules in the tax code, IRA assets can be transferred and split between spouses without taxation within one year of the formal divorce date. This is one where you want a skilled CPA and matrimonial attorney on your side, so the tax liability is minimized.
One thing not mentioned in the article is inherited IRAs, which the Supreme Court ruled are not protected from bankruptcy. If you, as the IRA owner, are worried about asset protection for your beneficiaries, you can protect your assets for them, through tools like a Standalone Retirement Trust.
Every situation is different, so speak with your estate planning attorney to make sure that your IRA assets are protected.
Reference: The Balance (Dec. 12, 2018) “What is IRA Bankruptcy Protection?”