Expenses do not stop when you enter retirement. This makes starting an Individual Retirement Account, or IRA, an important part of providing for your financial needs when you stop working. These accounts let you set aside money for retirement with tax advantages. However, if you have debts, you should be aware that creditors may have a right to your IRA funds.
Laws about debt collection vary by state. In some states, the law specifically states that IRAs are exempt from debt collection, Deborah L. Jacobs writes in The New York Times. In other states, IRAs are not exempt from collection attempts. Some of these states cap the amount of money protected, but others don't. Some states have rather unclear laws dictating that the IRA is exempt when it is necessary to meet your basic needs. However, the dollar amount necessary to meet basic needs is not clearcut from person to person. In some states, laws exist that, while not explicitly listing IRAs, state that retirement income is protected from creditors. Under these laws, any distributions you take from the IRA during your retirement years would be untouchable because IRA distributions are a form of retirement income.
If you decide to file for bankruptcy protection because of your debts, other regulations apply to IRA protections. In 1974, the government passed the Employee Retirement Income Security Act (ERISA). This law protects many retirement accounts, including 401(k) plans. However, to be qualified under ERISA, your interest in the plan must be non-transferable. You cannot give your interest in the plan away, nor can creditors take your interest from you, according to attorney Russell A. DeMott. This stipulation means that IRAs do not qualify under ERISA and thus are not protected from creditors, a point of confusion for many investors. However, another law, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), protects IRA investors for the first $1 million in the IRA account; anything over $1 can be sought by creditors. Distributions are not protected and become fair game once withdrawn. Additionally, you can roll money from a 401(k) account into an IRA. In this case, creditors cannot take the money in the IRA traceable to the 401(k), which sometimes is everything in the IRA.
One exception to BAPCPA is debt you owe to the Internal Revenue Service. The IRS' ability to levy IRAs is outlined in the Internal Revenue Manual, specifically sections 18.104.22.168.1, "Property Exempt from Levy," and 22.214.171.124, "Notice of Levy in Special Cases." The manual points out, however, that levying an IRA is a last resort and that the IRS should not levy IRAs except in "flagrant cases."
Technically, yes, a creditor can come after your IRA in some states. However, with the IRS being the exception, they still have to file a lawsuit in order to do this and get a formal levy order from a judge. You have the right to defend yourself against the creditor during this process and have the creditor prove you owe the debt. Because the protection under BAPCPA is so extensive, filing for bankruptcy makes many IRAs out of reach of creditors.
- Entrepreneur; How the New Bankruptcy Law Affects Your IRA; Debra Neiman; August 2005
- Bankrate.com; What Bankruptcy Reform Means to Consumers; Holden Lewis; March 2001
- Internal Revenue Manual: Part 5: Collecting Process
- The New York Times; Protecting Retirement Accounts from Creditors; Deborah L. Jacobs; April 2009