Are Your Retirement Assets Protected From Creditors?

Posted by John Posey on August 25, 2020

I’m hoping you’ll never need to find out, but are you familiar with what retirement assets are protected from creditors? What state you live in and what type of retirement account you own and where those funds originated from (ERISA vs. non-ERISA plan – explained shortly) will determine the level of creditor protection afforded to you. Here’s a link to a summary of creditor protection offered by state. The short answer is your retirement assets originated from employer-sponsored plans are likely to be protected at the highest, federal level.  Retirement assets accumulated as a self-employed person with no employees will only be protected to the extent allowed by state law. Retirement accounts that are covered by the Employee Retirement Income Security Act (ERISA) offer the best protection as it federal level protection. ERISA qualified retirement plans are those set up and maintained by an employer and comply with federal rules regarding reporting, funding, and vesting which include 401(k) plans, deferred compensation plans, pensions, and profit-sharing plans. This also typically includes SEP IRAs and SIMPLE IRAs, but ERISA status depends on whether the plan has employees beyond the owner and spouse. If the plan does not have employees beyond the owner and their spouse, it is a non-ERISA plan. Non-ERISA plans such as traditional IRAs, Roth IRAs, solo 401(k)s, and one-person SEP IRA or SIMPLE IRA plans do not offer a federal level of protection and revert to the protections available under state law. “Employer-sponsored” coupled with “employees beyond owners” seem to be the key words here when trying to decipher whether a retirement plan is considered ERISA covered or not.

IRAs are protected under a separate federal law but only if you file for bankruptcy. Federal protection of IRAs is limited by a $1 million exemption and states can follow federal law or create their own laws so the corresponding protections can vary widely per state. In short, if you have a situation where you need to know the details about the level of creditor protection, start digging into the law book in your applicable state of jurisdiction or contact a bankruptcy or ERISA attorney.

And if you wrangle with federal debts, retirement accounts can be garnished to satisfy them, so don’t expect to outfox Uncle Sam in any event. The other situation that can crack the nut of creditor protection for an ERISA plan is a qualified domestic relations order (QDRO), which is a special legal document found in a divorce settlement which generally grants the spouse 50% of the value of the account accumulated during the marriage. It should be noted that IRAs are split according to the divorce agreement, never via QDRO. Domestic related debts such as child support can become a source of retirement account garnishment, but ERISA covered plans do stand a better chance than non-ERISA plans in terms of being invaded to satisfy debts.

I also discovered an interesting tidbit regarding prenups, America’s favorite doctrine of love. Prenuptial agreements waiving spousal rights to employer-sponsored retirement plan assets don’t work. You might want to read that again. That’s right, a prenup waiving rights to your retirement assets is not quite enough to avoid the potential financial carnage. Why? Well, obviously your fiancé isn’t technically your spouse yet when they sign the prenup and ERISA law says only a spouse can waive rights to a company retirement plan. Now if you’re like me all I can say is “Holy crap. Really? That can’t be right!” Ed Slott and Company provided a real-life example of a case that involved a second marriage prenup between future husband and wife which waived claims to the other spouse’s retirement benefits and the husband had children from the first marriage. The husband intended to leave his retirement plan to his children from the first marriage upon passing.  Well, after his passing the surviving spouse went to court to claim the retirement benefits and won even though the prenup waived her rights. The verdict was based on the technicality that she was not in a spouse capacity when the prenup was executed and only a spouse can waive their rights to an employer-sponsored retirement plan under ERISA. It was suggested the only way to avoid this snafu is to have the spouse sign a spousal waiver literally after the ceremony! Nothing says “I love you” like a signed legal document. I wonder when we will start seeing this in the wedding vows. It might go something like this: “…I now pronounce you husband and wife, you may now kiss the bride”…Husband/wife: ”NO!..wait. Sign this first. I mean…I love you.”  Now stepmom’s litigious ways in this case make for an awkward Thanksgiving dinner among other things. I guess it’s true when they say money won’t change a person, but it will reveal them.

And here’s an important note on rollover IRAs. If the rollover IRA funds originated from an ERISA employer-sponsored plan, it will be federally protected from creditors and correspondingly will not be subject to the $1 million federal IRA exemption cap. SEP and SIMPLE IRAs also enjoy this same treatment if they qualify as an ERISA plan. If you have a situation like this and are evaluating the creditor protection, you may want to consult an ERISA attorney particularly if your account values are north of seven figures. The rules and implications can be cumbersome to navigate and directing the potential financial outcomes could be well worth the hire. Also, if you’ve accumulated more than a million in your rollover IRA you may have to produce records for the courts to show the amounts attributable to ERISA funds which could be a pain to put it lightly.  

And finally, I saved the most straight-forward fact for last - inherited IRAs are not protected from creditors. Your IRA inheritance will all be recovered by creditors before you’re legally allowed to write checks again – that’s my attempt at humor on full display. I hope you found this all interesting but not too personally useful. It’s many of the things you don’t need to know, that is until you do.

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