Many assume their retirement funds are protected from creditors, but depending on the type of retirement account you have—and the state where you live—this is not necessarily the case. The good news is that many employer-sponsored plans generally have the best protection. If you are concerned creditors might come calling, here is what you need to know.
- Most employer-sponsored retirement plans, such as a 401(k), fall under ERISA guidelines and are protected from creditors.
- Non-ERISA plans—such as traditional and Roth IRAs—do not have the same level of creditor protection.
- These retirement assets are nonetheless protected under a federal bankruptcy law if you file for bankruptcy.
ERISA-Qualified Plans Offer the Best Protection
Retirement accounts that qualify under the Employee Retirement Income Security Act (ERISA) are generally protected from creditors, bankruptcy proceedings and civil lawsuits. Your retirement assets are not at risk if your employer declares bankruptcy. In addition, creditors to whom you owe money cannot make a claim against funds held in your retirement account.
To be ERISA-qualified, a retirement plan must be set up and maintained by your employer (and/or a separate employee organization) and comply with federal rules regarding reports to plan participants, funding and vesting. Common types of ERISA accounts include 401(k) plans, deferred compensation plans, pensions and profit-sharing plans.
In addition to employer-sponsored plans, ERISA may cover employee health and welfare benefit plans. Common ERISA-covered plans include medical, surgical, hospital, or health maintenance organization (HMO) plans, health reimbursement accounts (HRAs), health flexible spending accounts (FSAs), dental and vision plans, prescription drug plans, disability insurance, life insurance, and 419(f)(6) and 419(e) welfare benefit plans.
The assets in these plans are typically held by an independent trustee and, as with many employer-sponsored plans, are exempt from seizure by any creditors.
Even retirement funds in ERISA plans may not be safe from an ex-spouse or the IRS.
The Power of the Anti-Alienation Clause
An important feature of an ERISA-qualified plan—such as a 401(k)—is the anti-alienation clause, which states that funds deposited in a qualified retirement plan are held by the plan administrator for the benefit of plan participants, and participants cannot freely sell, transfer, or give them away.
The clause also states that your rights to the benefits can’t be taken away, which effectively prevents creditors from getting the assets in your plan. The funds are not legally yours until you withdraw them as income during retirement, so they can’t be used to satisfy personal debts.
When ERISA Plans Are Vulnerable
ERISA-qualified plans may be at risk under certain circumstances and can be seized by:
- Your ex-spouse, under a qualified domestic relations order (QDRO), to the extent of your ex-spouse’s interest in the benefits as a marital asset or as part of child support
- The Internal Revenue Service, for federal income tax debts
- The federal government, for criminal fines and penalties
- Civil or criminal judgments, in cases of your own wrongdoing against the plan
Non-ERISA Plans Are Not Always Protected
Plans that are not ERISA-qualified do not offer the same level of protection when it comes to creditors, bankruptcy and lawsuits. Common types of non-ERISA retirement accounts include individual retirement accounts (IRAs) without substantial employer involvement, such as the traditional and Roth IRA. In addition, some types of 403(b) plans provided by government or churches may be exempt from ERISA.
Although IRAs are not ERISA-qualified, the funds are protected under a separate law—the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)—but only if you file for bankruptcy.
Depending on the state in which you live, your IRA and other non-ERISA plans may, or may not, be protected from creditors. Some states, for example, shield IRAs in nearly all instances, while others offer only limited protection. If you are at risk of creditors pursuing you, speak to a local attorney who understands the nuances of your state. The laws can be complex.
The Bottom Line
The ultimate value of your retirement account depends on many factors, including how much you save each year, your time horizon and the performance of the investments. However, there’s something else that can undermine your retirement funds: creditors.
While many employer-sponsored retirement accounts—including most 401(k)s—are protected against creditors, that’s not always the case. If you have questions about your plan and whether or not it is ERISA-qualified, speak with the plan administrator.