What is IRA Bankruptcy Protection?

When IRAs Are Protected from Bankruptcy

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Within certain limitations, individual retirement account owners can receive IRA bankruptcy protection. Whether you have a traditional IRA or a Roth IRA, the federal government extends significant protection from creditors in the event you declare bankruptcy.

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.

Is Your IRA Protected in a Bankruptcy?

IRA bankruptcy protection was signed into law by President George W. Bush under the 2005 Bankruptcy (BAPCA). The act took steps to insulate retirement funds from creditors by providing that contributions to various retirement plans are excluded from "property of the estate." 

The passage of BAPCA enabled for the first time protection for individual retirement accounts, including traditional IRAs, Roth IRAs and certain other individual retirement accounts. Prior to the 2005 act, the only qualified retirement plans that received bankruptcy protection were 401(k) plans, pensions, and similar employer-sponsored retirement plans. Initial protection provided by BAPCA was limited to a maximum of $1 million.

What IRA Bankruptcy Protection Covers

IRA bankruptcy protection covers all of the conventional individual retirement accounts, including traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, and rollover IRAs.

Protection extends up to a certain dollar amount, which typically increases on a periodic basis.

Here is a summary of IRA bankruptcy protection, according to BAPCA, based on the type of IRA:

  • Traditional IRAs and Roth IRAsHistorically, the limits on bankruptcy protection for IRAs have been adjusted every three years. The most recent adjustment was in 2016, when the limit of $1,283,025 was made.
  • SEP IRAs and SIMPLE IRAsThese IRAs are designed for self-employed individuals and small businesses. They receive the same protection as traditional IRAs and Roth IRAs.
  • Rollover IRAsBABCA identifies rollover IRAs as a traditional IRA or Roth IRA that was originally funded by a rollover transfer from an employer-sponsored retirement plan such as a traditional 401(k) or Roth 401(k).

In summary, the above limitations are extensive enough to cover the vast majority of IRA account holders because it covers every conventional type of IRA and the account balance maximums are higher than is ever attained by most IRA investors.

What's Not Covered Outside of IRA Bankruptcy Protection

IRA bankruptcy protection is quite extensive but outside of bankruptcy protection, some creditors can still claim assets in your IRA. Some examples of what's not covered outside of IRA bankruptcy protection includes general creditors, IRS levies, and divorce. 

General Creditors: Generally, there is no federal protection for IRA owners and the protection from general creditors varies by state law. Therefore, it is possible that general creditors can claim IRA assets, depending upon the state.

IRA Assets and IRS Levy: If you owe past taxes to the Internal Revenue Service, they can levy your pay and they can also levy your IRA.

Generally, the IRS will levy other assets before your IRA but your retirement account assets are not off limits to the IRS.

IRA Assets and Divorce: IRA assets are not protected from divorce but separating IRA assets is not absolutely necessary. What happens to your IRA assets in a divorce depends upon a court order and other assets that are held. For example, if your shared assets are $100,000 and $20,000 consists of IRA assets, both sides can agree where those assets come from (i.e.IRA assets remain with one divorcee and other assets distributed instead). Fortunately, 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.

The bottom line on IRA bankruptcy protection is that each case is unique. As with all matters that are related to legal questions, IRA owners should seek legal counsel to confirm what may happen with their IRA in their unique situation.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.