A previous post, found here, discussed the recent Supreme Court decision, in Clark v. Rameker, which held that inherited IRAs do not constitute retirement accounts and therefore do not receive the bankruptcy protections many such accounts receive. While that decision has a negative impact on inherited IRAs, and creates headaches for IRA owners wishing to aid in the financial future of their beneficiaries, the decision does not impact the protections afforded to non-inherited IRAs and ERISA qualified plans. This post will discuss the different forms of protection afforded to such retirement plans under both federal and state laws.
Since the 1992 Supreme Court ruling in Patterson v. Shumate, qualified retirement plans, subject to ERISA, have been exempted from a debtor’s bankruptcy estate. In 2005, this precedent was codified by the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) of 2005. This act exempted all money kept in employer-sponsored, qualified retirement plans, such as 401(k)s and profit-sharing plans, from a debtor’s bankruptcy estate. Additionally, the Department of Labor (“DOL”) and the Tenth Circuit have clarified that SEP and SIMPLE IRAs are also afforded this protection because they are considered ERISA pension plans due to the employer involvement in such plans. This means that all money accrued in a 401(K), SEP or SIMPLE IRA, profit-sharing plan, or any other ERISA qualified plan will be untouchable in bankruptcy proceedings.
The BAPCPA also affords bankruptcy protection to both traditional and Roth IRAs, which are not subject to ERISA; however, the protection provided for such accounts is substantially less than the protection provided to qualified plans. Unlike the Act’s unlimited bankruptcy protection for qualified retirement plans, the BAPCPA will only protect funds in a traditional or Roth IRA up to $1,245,475 per person. The original act only afforded protection for up to $1,000,000, but the number is adjusted every three years for inflation.
It is important to note that the BAPCPA only applies to bankruptcy proceedings. Protections available for other proceedings, such as garnishment or attachment, will depend on the type of retirement plan in question and the laws which apply to the plan. If a plan is an ERISA pension plan, it will be completely protected from nonbankruptcy proceedings initiated by the state. This is because of the ERISA provisions allowing ERISA to preempt state laws on such issues. Due to this, the ERISA anti-alienation provision, which provides that ERISA pension plans may not be assigned or alienated to others, prevents such plans from being reached in nonbankruptcy proceedings. Additionally, it is important to note that the ERISA protections for nonbankruptcy proceedings do not extend to IRA arrangements under Section 408 of the Internal Revenue Code, including SEP and SIMPLE IRAs.
For nonqualified plans, such as traditional and Roth IRAs, the nonbankruptcy protections are dependent on applicable state laws, which vary greatly from state to state. Some states, such as Indiana, provide unlimited protection for both traditional and Roth IRAs in nonbankruptcy proceedings; some states provide unlimited protection for traditional IRAs but not Roth IRAs; and other states provide very limited protection for traditional IRAs and none for Roth IRAs. Due to the difference in protection from state to state, it is important that IRA owners be aware of the statutes which apply to their account.
Protection for SEP and SIMPLE IRAs in nonbankruptcy proceedings is a complicated issue. While it is true that such plans are considered ERISA pension plans and thus receive unlimited protection in bankruptcy proceedings, as mentioned above, they are not protected by the ERISA anti-alienation provision. Additionally, because SEP and SIMPLE IRAs are ERISA pension plans, they generally are not protected under any state laws due to the ERISA preemption provision. This leaves SEP and SIMPLE IRA plans in a precarious position as it is appears that such plans will receive no protections in nonbankruptcy proceedings; in fact, the Sixth Circuit has held this to be the case. Because of the lack of protection for SEP and SIMPLE IRAs in nonbankruptcy proceedings, owners of such accounts may wish to protect their funds by rolling the assets of their existing SEP or SIMPLE IRA into a rollover IRA. In doing so, account owners will make it so their plans are no longer subject to ERISA, thus allowing their assets to be protected from nonbankruptcy proceedings in accordance with the applicable state laws, and protected up to $1,245,475 in bankruptcy proceedings, in accordance with the BAPCPA.