If you declare bankruptcy, your IRA money could be seized by your creditors, depending on what state you live in. IRA protection from creditors is currently governed by states, not the federal government, and the state laws are far from uniform.
But a bankruptcy bill pending in Congress contains new, strong federal rules that would protect most IRA assets. Creditors wouldn't be able to touch money that was rolled into an IRA from employer-sponsored retirement savings plans such as 403(b)s and 401(k)s, and the continued earnings on that money would also be exempt from creditors.
The law would allow creditors to seize IRA assets over $1 million that come from contributions directly to the IRA, and not from employer plan rollovers. But since IRA contributions have been limited to $2,000 a year since IRAs were created in 1974, this probably isn't anything to worry about.
"It's hard for me to believe that many people will be affected by this," said Sam Murray, vice president of government affairs with the Profit Sharing/401(k) Council of America. "It will take 40 years for a person to have ... in excess of $1 million."
IRA Law Patchwork
Historically, money in IRAs hasn't been protected from creditors by federal law. Instead, an uneven patchwork of state laws governs the way that IRAs are treated in the event of personal bankruptcy.
In contrast, the assets in all 401(k) and some 403(b) plans are protected from creditors by the Employee Retirement Income Security Act. This Federal law requires these retirement plan assets to be kept in separate trust accounts that can't be touched by creditors of either the employer or the employee. ERISA was passed in the 1970s when many companies were raiding their pension funds and other benefits for operating cash. The federal government stepped in and passed the law in order to protect employee benefits.
IRAs and 401(k) plans are treated differently because they are defined by separate sections of the Internal Revenue code. 401(k)s, and some 403(b) plans, are employer-sponsored plans and are required to comply with a different set of regulations than IRAs. Because IRAs are not employer plans, they are considered personal property. As such, IRA assets are governed by state laws that cover personal property disposition.
If passed, this law would extend new federal protections to IRA accounts even in states that have not had strong bankruptcy protection regulations.
The pending bill is dramatically different in tone from one introduced a year ago. That one proposed allowing creditors to seize any IRA assets worth more than $1 million, without regard to the source of the IRA balance.
That bill alarmed some retirement experts because it meant that rollover IRAs with large balances from an employer-sponsored retirement plan could be vulnerable to creditors. Rollover IRAs tend to have larger balances than IRAs that are funded only by annual contributions. This is because 401(k) and 403(b) contribution limits ($10,500 in 2001) have always been higher than IRA contribution limits and many employee contributions are also augmented with employer-matches.
IRAs are increasingly being used as a long-term parking place for money accumulated in 403(b)s and 401(k)s. Behind investment gains, rollovers were the second-leading factor spurring growth in IRA assets in 1999, the Employee Benefit Research Institute reported in January 2001.
So, retirement activists geared up a massive lobbying campaign last year to get the bill's language changed. "Philosophically, our goal was to extend coverage to all" retirement accounts, said David Wray, president of the Profit Sharing/401(k) Council of America, one of the leading industry groups lobbying Congress for additional protections.
For reasons unrelated to the IRA provisions, the bill failed to pass Congress in 2000, so advocates prepared for its reintroduction this year.
The lobbying campaign showed results in this year's bill. It wasn't easy to make progress, though, Murray said. Most of the congressional staffers he dealt with weren't familiar with the Department of Labor regulations that govern employer-sponsored retirement savings plans.
"Philosophically, our goal was to extend coverage to all" retirement accounts.
| David Wray, president of the Profit Sharing/401(k) Council of America
As the new legislation indicates, the lobbying groups have successfully managed to persuade Congress that IRAs need extra protection if they're holding money in transit from one employer retirement plan to another.
Here are key provisions of the pending legislation:
- All contributions and earnings from employer-sponsored retirement plans currently held in an IRA would be protected against creditor claims if you declare bankruptcy. However, you would still have to maintain the paper trail showing that the money originally came from an employer plan, said James Delaplane, vice president of retirement policy with the American Benefits Council. Strategy: Put any money you roll out of an employer plan into a conduit IRA (an IRA that only holds rollover money), and don't make any annual contributions to that IRA. That will make it easy to maintain the paper trail.
- Creditors could attach IRA assets over $1 million that you built with your own contributions (not from an employer plan) and earnings on those contributions. Most people wouldn't be affected by this provision unless they made full $2,000-a-year contributions for more than 40 years, retirement experts say.
- Money saved in SEP-IRAs and SIMPLE IRAs would be excluded from the $1 million cap, according to Sam Murray of the Profit-sharing/401(k) Council of America.
- If you are doing a rollover from an employer plan to an IRA or vice-versa, any retirement account money in your hands within the 60-day rollover period is also protected from creditors.
- If you actually withdraw money from an IRA or employer-sponsored retirement plan, it's no longer protected from creditors.
- The $1 million cap will periodically be adjusted upward to match inflation.
Prospects for Passage
Different versions of the bill have been passed in the Republican-controlled congress, on mostly party-line votes. President Bush has also said he will sign the bill.
With regard to the IRA provisions, the bills are relatively identical. But, there is a sticking point, political maneuvering between Senate Democrats and Republicans. Before the bill can be sent to the president to be signed into law, members of the House and Senate must meet in a conference committee and iron out the differences between their two versions. The conference committee's make-up has still not been determined, and probable changes in the Senate leadership means that it may take a while before all the disagreements are resolved. On the other hand, there may be a rush to implement bills like this before the leadership changes are complete.
So, until a conference committee has been appointed, the timing of this legislation's enactment remains unknown.