Are a debtor's retirement plan assets exempt from the individual's bankruptcy estate? Until 2005, the answer to this question depended on whether the retirement plan holding the assets was an ERISA or a non-ERISA retirement plan. For non-ERISA retirement plans, the level of protection was determined by the laws of the debtor's state of residence, while the protection for ERISA plans was based on federal law. Protection for non-ERISA plans became uniform when the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 was signed into law on April 20, 2005. In this article, we highlight the protection that now exists for both ERISA and non-ERISA plans.

SEE: Should You File For Bankruptcy?

Application and Effective Date of BAPCPA
As stated under Public Law No. 109-8, the primary goal of BAPCPA is to amend federal bankruptcy law to revamp guidelines governing dismissal or conversion of a Chapter 7 liquidation (i.e. complete relief in bankruptcy) to one under either Chapter 11 (reorganization) or Chapter 13 (adjustment of debts of an individual with regular income). However, the Act includes provisions for retirement plans including Traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, qualified plans, 403(b) plans, 457 plans and education savings accounts (ESAs). Limitations apply in some cases, while unlimited protection applies in other cases. These are explained below.

Note that BAPCPA applies to bankruptcy petitions that have been filed at least 180 days after April 20, 2005, the date the Act was signed into law. This means that bankruptcy petitions filed before October 17, 2005 will be subject to the rules that were in effect before BAPCPA.

Retirement plans that meet the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) are excluded from an individual's bankruptcy estate. This was determined by the Supreme Court in its ruling on the landmark case Patterson v. Shumate, 504 U.S. 753 (1992), where it was ruled that ERISA plans are excluded from an individual's bankruptcy estate as provided under Section 541(c)(2) of the Federal Bankruptcy Code. BAPCPA solidified this provision by providing bankruptcy protection for unlimited amounts in employer-sponsored plans.

When Qualified Plans Are Not ERISA Plans
The question of whether qualified plans are protected under ERISA used to depend on whether they were "employee benefit plans" under title 1 of ERISA. Qualified plans that covered only the business owner (which by definition includes the business owner's spouse) did not meet such requirements and, therefore, were not afforded bankruptcy protection under ERISA. Instead, protection was determined under individual state laws until BAPCPA became effective. Under BAPCPA, such plans are now fully excluded from an individual's bankruptcy estate.

SEE: What is the difference between qualified and non-qualified plans?

Until the effective date of BAPCPA, the matter of whether Traditional, Roth, SEP or SIMPLE IRA assets were excluded from a debtor's bankruptcy estate was settled according to the laws of the debtor's state of residence. Under BAPCPA, the following exclusion rules now apply on a federal level:

Traditional and Roth IRAs
Traditional and Roth IRA assets are excluded up to a limit of $1 million. This amount is set to be reviewed every three years to determine whether the $1-million threshold should be increased based on the Consumer Price Index (CPI). This limit does not include amounts rolled over from SEP IRAs, SIMPLE IRAs and other employer-sponsored retirement plans, including qualified plans.

SEP and SIMPLE IRA assets are excluded from the debtor's bankruptcy estate for unlimited amounts - unlike Traditional and Roth IRAs, which are limited to $1 million.

Education Savings Accounts and 529 Plans
The following limitations apply to Coverdell education savings accounts (ESAs) and 529 plan assets:

  • Ineligible or excess contributions to ESAs are not excluded from the debtor\'s bankruptcy estate.
  • Amounts contributed to an ESA within 365 days before the bankruptcy is filed are not excluded from the debtor\'s bankruptcy estate.
  • Amounts contributed to ESAs and 529 plans between 365 and 720 days before the bankruptcy filing are limited to an exclusion amount of $5,000.
  • While anyone can contribute on behalf of a designated beneficiary, only amounts contributed to the accounts of a child, stepchild, grandchild, or step-grandchild of the debtor for the taxable year for which funds were placed in such account are excludable.

BAPCPA is viewed as an unwelcome piece of legislation by many debtors who file for Chapter 7 bankruptcy, as it removes the option of complete dissolution of debts and requires these individuals to reorganize or adjust much of these debts. However, one upside is that retirement plan assets can now be excluded for unlimited amounts - that is, except for the limitations listed above which are placed on Traditional and Roth IRAs and ESAs. If you do own Traditional IRA assets, it may make sense to keep those assets separate from assets that are rolled over or transferred from employer-sponsored plans. If you intend to file for bankruptcy, be sure to consult with your attorney for guidance on the appropriate steps to take and for assistance in ensuring that you receive the maximum available protection offered for your assets.

For more insight, read Build A Wall Around Your Assets.

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