Bankruptcy and retirement accounts
In a recent article published in Financial Planning magazine, Ed Slott (www.irahelp.com) pointed out that there are differences among retirement plans when it comes to protecting your assets in bankruptcy and other legal proceedings. Some of these protections vary from state to state. Here’s an outline of some of the differences.
For example, assume John establishes a contracting business as a sole proprietor. He has established 401(k) plans for both himself and his employees. Assume further that a client sues John over an accident associated with his business. The assets in John’s 401(k) remain protected under ERISA up to an unlimited amount. Even if John declares bankruptcy, the assets in his 401(k) are fully protected. This would not necessarily be the case if the assets were held in an IRA.
Solo 401(k) plans are not covered by ERISA. Creditor (non-bankruptcy) protection may be available under state law. However, solo 401(k) plans receive full bankruptcy protection under the bankruptcy code. This is also the case with other non-ERISA plans, including Simplified Employee Pension plans, simple IRAs, non-ERISA 403(b) plans and 457(b) government plans.
IRA accounts do not have the non-bankruptcy protection associated with ERISA accounts. So if a plaintiff wins a case against an IRA owner and is awarded a judgement, the owner is not protected as he would be if the account was held in an ERISA account. In this case, state law determines owner protection. For this reason, an owner of an ERISA account should be wary of rolling over an ERISA account to an IRA if there is concern about non-bankruptcy lawsuits. ERISA account owners should discuss such a rollover with an attorney familiar with state law protection before using an ERISA rollover to an IRA.
If a 401(k) account is rolled over to another 401(k) plan, it would retain the non-bankruptcy protection it would not have if it was rolled over into an IRA.
The bottom line is that the rules associated with protecting retirement accounts are complex, and retirement plan owners should use the advice of their attorneys and/or knowledgeable financial planners in order to protect themselves.