Hello everyone and welcome to the podcast. I’m Elean Mendoza and I’m here with Evan Shorten the Firm’s founder and principal.
Hello everyone. First off, I want to thank everyone who listens to the podcast. We noticed there has been an increasing number of people listening over the last few months and I just want to say thank you. If you listen to our podcast and you have not subscribed, please do so wherever you normally listen. You can subscribe on the Apple podcasts app, Stitcher Radio, or on our YouTube channel. Again, thank you so much for tuning in.
Ok, so a big part about managing wealth is protecting your wealth. For many individuals a significant portion of their wealth is held inside retirement accounts. So that means protecting your nest egg from outside creditor claims is paramount to ensuring your wealth can sustain you through your retirement years and even leave a legacy for your heirs.
So first, let’s clarify a few terms. In this episode, when we say outside creditor we are referring to anyone trying to make a claim on your retirement accounts. This could be a claim from bankruptcy proceedings, a law suit, a former spouse, and so on. Essentially, someone who’s coming after your money.
With that said, in general retirement accounts receive special protections from creditors under federal law, and in many cases, state law. However, the amount of protection your retirement accounts receive is highly dependent on account type and the state you reside in. That’s somewhat reassuring but also not.
Honestly, there is a lot to unpack in that statement – federal protection, state protection, account type, residence, etc.
Let’s start with Federal protections as it’s the broadest and most encompassing level of protection for your retirement accounts. The Employee Retirement Income Security Act of 1974, also referred to ERISA, actually provides a good level of protection over your retirement accounts and your employee welfare benefits like your health insurance, vacation days, and so on. Essentially, under ERISA laws creditors cannot seize or garnish your retirement plan assets. ERISA actually provides the highest level of protection against creditor claims, essentially making your ERISA covered retirement assets untouchable by a creditor.
Now, you might have noticed I specifically said ERISA covered retirement assets. This is an extremely important detail as not all retirement accounts fall under the purview of ERISA. So to be specific, ERISA covers employer sponsored retirement accounts. That includes your employer’s 401k, 401a profit sharing plans, 403b, and many defined compensation plans.
If you notice, there were a few notable employer retirement accounts I didn’t mention in the list of what’s covered under ERISA – Individual or Solo 401k, SEP IRA, or SIMPLE IRA. Unfortunately self-employed accounts do not fall under ERISA and therefore have a different set of federal protections.
We’ll come back to those in a bit. For now, let’s finish the discussion on ERISA covered plans.
Ok, so now that we established your ERISA covered, employer retirement account is federally insulated from creditor claims, it’s also important to mention that as with everything in life, there are always exceptions to the rules. With regards to ERISA covered retirement plans, there are 4 major exceptions that could allow a creditor to make a claim on your retirement assets.
- Divorce – payments awarded to a former spouse under a qualified domestic relations order, also known as a “QDRO.” This occurs in a divorce when a judge awards part of your retirement account to your spouse during the divorce proceedings.
- The IRS – Federal law may keep most creditors away from your retirement plan, but it’s not going to lock itself out. Liens imposed by the IRS are also exempt from ERISA protections.
- Federal criminal fines or penalties.
- Civil or criminal judgments for damage a participant causes to a retirement plan.
Ok, I think that was a pretty in-depth explanation of the protections ERISA provides for your employer sponsored retirement plan. Now referring back to the Individual 401k, SEP and SIMPLE IRAs, are those plans protected from creditor claims since they don’t fall under ERISA?
So for the purposes of brevity, Individual 401ks, SEP IRA, and SIMPLE IRAs are treated as individual retirement accounts as opposed to employer sponsored retirement accounts. The reason being is that these accounts are specifically for employers with a single employee, who is the sole proprietor. So with that said, Individual 401k, Roth IRAs, SEP IRAs, SIMPLE IRAs, and traditional IRAs all receive Federal protections against creditors under bankruptcy laws, specifically the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
Now under federal bankruptcy protection, most IRAs are covered. First, any amount rolled over from a qualified ERISA plan is protected in bankruptcy. Second, federal bankruptcy shields up to $1,512,350 of your IRA contributions and earnings on those contributions.
To quickly clarify as sometimes the rules can be confusing. The $1,512,350 refers to your annual contributions and earnings on those contributions. It does not refer to the value of your IRA.
Correct. Given that IRAs weren’t created until 1975 and had an original contribution limit of $1,500, it’s not possible to have contributed anywhere near that amount. In other words, most IRAs are protected under bankruptcy with a few notable exceptions like Mitt Romney’s famous $102 million IRA or Peter Thiel’s $5 billion Roth IRA.
Additionally, every state has its own bankruptcy protection laws as well. Depending on where you live, your IRA could be protected far beyond what federal bankruptcy protection provides.
Ok so far we pretty much talked about creditor protections for bankruptcy. Of course there are multitude of reasons that a creditor may come after you. So Evan, are retirement accounts insulted from civil lawsuits and if so, to what extent?
Earlier in the podcast we mentioned that employer sponsored retirement accounts covered by ERISA have the best protections against creditors. That is still the same when it comes to civil lawsuits. However, IRAs are a different story.
IRA protections for civil matters are actually governed by the individual states themselves and sometimes leave the amount of protection your IRA receives up to a judge’s discretion.
To give you an idea how IRA protections vary between individual states, we’ll cover some of the states where the majority of our client’s reside.
Arizona protects your Roth and traditional IRA almost entirely. With the small caveat that any contributions made within the last 120 days are open to creditor claims.
California does not provide any significant creditor protections for Roth IRAs and only provides creditor protection for your traditional IRA according to a judge’s discretion.
Nevada protects your Roth and traditional IRA up to a present value of $500,000.
Florida fully protects your traditional and Roth IRA from creditors along with the District of Columbia; New Jersey; New York; Oregon; Texas; and Utah.
I’m not going to name all 50 states as that would take too long, but those examples should give you an idea of the wide variation.
Now there is one other type of retirement account we have not discussed yet and it has its own set of unique circumstances.
Yes. Inherited IRAs present a unique situation. Back in June 2014 the Supreme Court ruled in Clark vs Rameker, that inherited IRAs do not receive the same creditor protections in bankruptcy as traditional and Roth IRAs. To sum up the Court’s reasoning, “Inherited IRAs hold funds that can be freely used for current consumption, not funds objectively set aside for one’s retirement.” In other words, inherited IRAs have three key differences that don’t actually make them “retirement accounts.”
First, the beneficiary of an inherited IRA may never contribute additional funds into the account.
Second, Most inherited IRA holders are required to withdraw funds regardless of how far from retirement they.
Third, the beneficiary of an inherited IRA may withdraw the entire balance of the account at any time without penalty, whereas early withdrawals from traditional or Roth IRAs may incur tax penalties.
Ok so we covered a lot today, but before we let you go let’s go over a few options that may help you better protect your retirement assets. As a reminder, if you’re currently working and your retirement assets are help with an employer sponsored plan covered by ERISA, you don’t need to do much. ERISA has the strongest protections against creditors.
But if you’re retired or don’t have access to an employer sponsored retirement plan covered by ERISA, Evan what are some options?
Well the first couple of things you can do is take preemptive action. Meaning, don’t get into a dispute with the IRS, don’t get behind on child support or alimony if you’re divorced. If you recall, we mentioned that the IRS and the US Government can still make claims on your retirement accounts. In addition, a judge can make a claim on your retirement accounts if you fall behind on court ordered payments resulting from a divorce.
Lastly, don’t forget about maintaining adequate insurance. Make sure your auto insurance and home owner’s insurance are high enough to cover a serious accident. If you own your own business or provide professional services, it may be time to add or review your professional malpractice insurance. Additionally, it’s important to maintain an umbrella insurance policy. An umbrella policy can be added on top of your other insurance policies to cover excess costs going beyond what those policies cover. If you’re at the stage in life where you have accumulated a substantial amount of assets, it’s extremely important to have an umbrella policy or a personal liability policy as it’s also called.
Ok great. Thanks Evan. We know this podcast was a little longer than our normal episodes so we’re going to wrap things up. If you would be so kind, please subscribe to the podcast if you have not done so already. If you think anyone would be interested in learning about this topic or would benefit from the content, please don’t hesitate to forward it to them. Thank you for listening, and we’ll see you here next time.