Can a Creditor reach your IRA?

Assets in qualified retirement plans such as 401 (k) plans, defined benefit pension plans, and profit sharing plans, are specifically protected from the claims of creditors by the provisions of the Employee Retirement Income Security Act of 1974 (ERISA) and a 1992 decision of the Supreme Court of the United States, Patterson v. Shumate.

In contrast with qualified employer plans, IRAs are not covered by ERISA or the Patterson v. Shumate decision. Therefore, the extent to which IRAs are protected from creditors’ claims is determined by state law, which varies from state to state. Most states have statutes protecting IRAs to some degree.

Pennsylvania’s statute provides significant protection against attachment and execution of judgments against IRAs by creditors. Pennsylvania law protects contributions to an IRA up to $15,000 per year. Contributions over $15,000 per year are available to creditors. Importantly, the Pennsylvania statute was amended in 1998 to provide that rollovers from qualified employer plans do not constitute “contributions” for purposes of the $15,000 limit. Thus, a direct transfer from a qualified retirement plan already subject to creditor protection (such as a qualified employer plan) to an IRA retains the same protection.

A different rule applies if the owner of the IRA is in bankruptcy. In April 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA). In general, BAPCA not only tightened the rules for personal bankruptcies, but it also made significant changes in the area of retirement plans. Under BAPCA, all retirement funds including IRAs are now protected from the reach of creditors. Finally, there is uniform treatment of IRAs and qualified plans in bankruptcy with one exception – the amount of the protected IRA assets (whether in a traditional IRA or a Roth IRA) is limited to $1 million (adjusted every three years for inflation). The protection of IRAs under BAPCA applies without regard to the state in which the debtor resides and without regard to the extent to which the IRA assets are necessary for the support of the debtor and his or her family.

Distributions from all defined-benefit and defined-contribution employer retirement plans fully retain creditor protection if they are rolled over to an IRA (without regard to the $ 1 million limitation), obviating the “need” to keep assets in ERISA plans for bankruptcy creditor protection. Outside of bankruptcy, the laws in effect prior to BAPCA continue to apply. That means that in Pennsylvania, the status of IRAs is still governed by the state law which refers to the $15,000 per year contribution. In a state where the law does not protect retirement plan assets outside of bankruptcy, the debtor may be forced to file for bankruptcy in order to secure the protection now given by BAPCA.

Since Pennsylvania law allows rollovers to IRAs to be protected, and since the vast majority of IRA owners do not contribute more than $15,000 per year (which is far above the deductible limits), most IRAs in Pennsylvania cannot be reached by creditors either outside of bankruptcy or in bankruptcy.

Theoretically, if an IRA funded with contributions, not rollovers, exceeded $1 million, it would not be 100% protected in bankruptcy, but that would require some phenomenal investment returns if only tax deductible amounts were contributed – so again, in most cases, the IRA cannot be reached.