As individuals continually find new ways to save for retirement, it is important to examine their level of vulnerability to creditors’ claims. Individual retirement accounts ("IRAs") are helpful tools which allow a person to set aside money for retirement while also providing potential tax advantages. Unlike ERISA qualified retirement plans (e.g., 401(k), 403(b)), which enjoy unrestrained creditor protection, IRAs are afforded creditor protection on a more limited basis depending on their categorization and the relevant law being applied.
The Employment Retirement Income Security Act of 1974 was passed in an effort to remedy a host of problems associated with employee benefit plans. By creating minimum standards, ERISA sought to ensure the "equitable character of such plans and their financial soundness." 29 U.S.C. § 1001 (2006). Through its legislative provisions, an individual’s interest in an ERISA qualified retirement plan is protected from creditors. see Patterson v. Shumate, 504 U.S. 112 (1992). Furthermore, federal bankruptcy law offers unlimited creditor protection for ERISA plans and all non-ERISA plans which are exempt from taxation.
Whether creditor protection is available to an IRA depends on the state and its applicable laws. Though every state possesses its own bankruptcy exemptions, Virginia is an opt-out jurisdiction; this means that Federal Bankruptcy exemptions are applied to retirement plans. Va. Code §34-34 (2007). In recent years, the security provided to IRAs has expanded due to newly enacted federal legislation.
The Bankruptcy Abuse Prevention and Consumer Protection Act was signed by the President in 2005. While the law was largely enacted to make it more difficult for debtors to discharge debt, certain provisions provide more expansive creditor protection. Section 224 of the BAPCPA allows protection to IRAs which would not have otherwise been provided to them under federal or state law. Though increased protection is given under the BAPCPA, limitations are imposed.
Creditor protection for IRAs is only provided in bankruptcy; therefore, the BAPCPA does not apply when a judgment is rendered in another court where state law applies. ERISA is not similarly restricted in that it applies to judgments other than bankruptcy, regardless of applicable state laws. Additionally, the type of IRA created will determine the protection it is given. Section 224(e) creates a $1 million inflation adjusted cap on the value of a debtor’s interest which may be claimed as exempt from his bankruptcy estate. This cap is instituted when dealing with Roth IRAs or traditional IRAs. In contrast, eligible rollover accounts (such as a 401(k), a 403(b), or a profit sharing plan) have unlimited exemption and are therefore not subject to a similar cap. Due to the different treatment afforded to varying IRAs, all roll over assets should be kept in a separate IRA from contributory assets.
While IRAs do not enjoy the extensive creditor protection afforded to ERISA qualified plans, they do provide a level of creditor security. When assessing the degree of creditor protection afforded, both the specific type of IRA and the relevant jurisdiction should be examined.