Are Your IRAs Protected From Creditors?

An Individual Retirement Arrangement (IRA) is a tax-advantaged savings plan for retirement. A common concern for account holders is the safety of these assets from potential claims by creditors. The security of these funds is not absolute and depends on a variety of legal frameworks and specific personal circumstances.

Federal Bankruptcy Protections

The primary shield for IRAs at the federal level comes from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). This legislation provides protection for retirement funds when an individual files for bankruptcy. For contributory IRAs, which include both traditional and Roth IRAs funded by direct contributions, there is a specific, inflation-adjusted cap on the amount protected per person, not per account.

This aggregate limit applies to the total value of all of an individual’s contributory IRAs. The amount is adjusted for inflation every three years. This protection ensures that a substantial portion of an individual’s self-funded retirement savings is preserved during bankruptcy proceedings, allowing for a financial fresh start.

A different protection applies to retirement funds that originate from employer-sponsored plans. Rollover IRAs, funded by moving money from a plan like a 401(k) or 403(b), are granted unlimited protection under federal bankruptcy law, as are SEP and SIMPLE IRAs. The reasoning is that these funds were initially protected under the Employee Retirement Income Security Act of 1974 (ERISA) and retain that protected status when rolled into an IRA.

Funds maintained in a rollover IRA are entirely exempt from a bankruptcy estate, regardless of the dollar amount. This provides an incentive for individuals to consolidate old employer plan assets into a rollover IRA rather than combining them with contributory IRAs. Keeping these funds separate ensures they receive the unlimited protection afforded under federal law.

State Law Protections

Beyond the federal bankruptcy code, every state has its own laws governing asset protection, and these statutes often provide a separate shield for IRAs. These state-level protections are relevant in non-bankruptcy situations, such as when a creditor obtains a court judgment to seize assets. In these scenarios, an account holder must rely on the laws of their state of residence.

The scope of protection offered by state laws varies. Many states offer protections more generous than the federal bankruptcy cap for contributory IRAs, with some providing unlimited protection against creditors for all types of IRAs. Other states may set their own specific dollar limits or protect only the amount deemed necessary for retirement support.

These state exemptions also play a role within a bankruptcy case. When filing for bankruptcy, a debtor can often choose between using the set of exemptions provided by federal law or the exemptions offered by their state of residence. If a state’s IRA exemption is more favorable than the federal cap, a debtor would likely choose the state exemptions to protect a larger amount of their retirement savings.

Inherited IRA Considerations

The protection status changes when an IRA is inherited by someone other than a spouse. The U.S. Supreme Court addressed this in its 2014 decision, Clark v. Rameker. The court ruled that an IRA inherited by a non-spouse beneficiary does not qualify as a “retirement fund” under the federal bankruptcy code. As a result, these assets are not protected from the beneficiary’s creditors in a bankruptcy proceeding.

The Court’s reasoning was based on key differences between a contributory and an inherited IRA. An individual who inherits an IRA cannot make additional contributions, is often required to take distributions regardless of age, and can withdraw the entire balance without penalty. The Court concluded these features mean the funds are no longer held for the beneficiary’s own retirement, making them accessible to creditors.

An exception to this rule exists for a surviving spouse. When a spouse inherits an IRA, they have the option to treat it as their own by rolling the assets from the deceased spouse’s IRA into their own IRA. By doing so, the account is no longer considered “inherited” and receives the same federal and state protections as any other IRA.

Exceptions to Creditor Protection

Despite the strong protections available, certain debts can bypass the shields provided by federal and state laws. The most prominent exception involves the Internal Revenue Service (IRS). If an individual has outstanding federal tax liabilities, the IRS can issue a levy to seize funds directly from a traditional or Roth IRA to satisfy the debt.

Another exception relates to domestic relations matters. Funds in an IRA can be accessed to satisfy obligations for alimony or child support. When an IRA is divided during a divorce, the movement of assets is handled as a “transfer incident to divorce,” which is outlined in the divorce decree. This allows a portion of an IRA to be transferred to a former spouse to meet family support obligations.