Retirement accounts are typically protected from creditors and lawsuits, but there are certain circumstances in which an IRA or other retirement account may be vulnerable. The federal Bankruptcy Abuse and Consumer Protection Act of 2005 provides protection for qualified retirement accounts, with unlimited protection for most types of retirement plans. However, IRAs receive limited protection, with the protected amount adjusted for inflation every three years, currently up to $1,512,350.
IRAs funded entirely with rollovers from qualified employer plans, such as a 401(k), have no limit on protection from creditors. Inherited IRAs, on the other hand, are not protected under federal law, and spouses may be awarded a share of an IRA in a divorce. The IRS also has the ability to place a lien on an IRA for overdue amounts owed to the government. Each state has its own laws regarding the extent to which retirement accounts can be reached by creditors, potentially providing more protection than federal law.
It is important to check both federal and state laws to determine the level of protection for an IRA or other retirement account. Moving to a state with more protection or distributing the money from the IRA, paying taxes, and restructuring how the after-tax amount is held are options for those vulnerable to lawsuits. Some may consider moving the money to a trust or family limited partnership, purchasing a life insurance policy, or giving the money to loved ones who are less vulnerable to potential claims from creditors.
When an IRA is subject to creditor claims, the seizure or forced distribution from the IRA is considered a distribution to the owner, potentially resulting in income tax consequences. It is important to be aware of the potential tax implications of distributions from an IRA. For those concerned about IRA beneficiary creditors, naming a trust as the IRA beneficiary and having an individual as the beneficiary of the trust can provide additional creditor protection in most states, although this could result in higher taxes on distributions from the IRA.
