Qualified Retirement Plan Creditor Protection

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By Rebecca Olson, J.D., CISP, CPC

Are assets in a qualified retirement plan (QRP) (e.g., 401(k) plan, profit sharing plan) protected from creditors under federal law?

Outside of Bankruptcy. Protection from creditors under federal law depends on whether the QRP is covered by the Employee Retirement Income Security Act (ERISA). For this purpose, a QRP is considered to be covered by ERISA if the plan covers one or more employees other than the business owner and the owner's spouse. Where applicable, ERISA requires that as a condition of qualification, a plan contain anti-alienation language. This language provides that benefits under the plan may not be assigned or alienated. As a result, a debtor’s assets in an ERISA QRP are protected.

In Bankruptcy. In 2005, Congress passed legislation—The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the Bankruptcy Act of 2005)—permanently exempting QRP assets from bankruptcy estates under federal law. An individual filing for bankruptcy can protect assets in retirement plans established under Internal Revenue Code (IRC) Sections 401, 403, 408, 408A, 414, 457, or 501(a). This includes assets in a 401(k) plan, 403(b) plan, profit sharing plan, governmental 457(b) plan, pension plan, Traditional, Roth, or SIMPLE IRA, and SIMPLE 401(k) plan. Protection for Traditional and Roth IRAs, however, is not unlimited, and currently is $1,283,025 (subject to adjustments).

How are owner-only plans, such as an Individual(k)™ plan, impacted?

Outside of Bankruptcy. Because owner-only plans are not subject to ERISA, the anti-alienation clause does not apply. As a result, the plans may be subject to attachment (seizing) by creditors.

In Bankruptcy. The Bankruptcy Act of 2005 does not draw a distinction between owner-only non-ERISA plans and ERISA tax-qualified retirement plans. As a result, once the owner files for bankruptcy, assets in the non-ERISA plan are protected from creditors.

What is the effect on creditor protection if QRP assets are rolled over to an IRA?

Outside of Bankruptcy. When an IRA owner has not filed for bankruptcy, IRAs have no protection from creditors under federal law. As a result, whether the assets originated in an ERISA or non-ERISA plan, those assets may be subject to the claims of creditors.

In Bankruptcy. The Bankruptcy Act of 2005 protects all assets that originated in a QRP plan (whether subject to ERISA or not) provided they are still in a qualified retirement account (e.g., a Traditional IRA or Roth IRA). As a result, as long as the individual can show that the assets in the qualified account originated in a QRP, those assets are protected under federal bankruptcy law.

I have clients with SEP and SIMPLE IRA plan accounts. How are those accounts impacted?

Outside of Bankruptcy. Before an individual files for bankruptcy, SEP and SIMPLE IRA plan accounts are treated as IRAs and will follow the IRA rules for creditors mentioned above. As a result, the assets in a SEP or SIMPLE IRA plan account may be subject to claims of creditors, depending on state law.

In Bankruptcy. Once an individual files for bankruptcy, the SEP and SIMPLE IRA plan accounts are covered by the Bankruptcy Act of 2005, and therefore, the assets are fully protected under federal bankruptcy law.

How does state law come into play?

States may provide greater protections for retirement funds than required by the federal rules. Check with an attorney familiar with the specific state’s laws for more information.