Bankruptcy provides protection from creditors and a fresh financial beginning. Despite its benefits, however, bankruptcy can also deplete a debtor's assets, such as cash accounts, investments and personal property. On the other hand, some assets receive protection from seizure in bankruptcy, including Individual Retirement Accounts, or IRAs.
The language in the United States Bankruptcy Code does not specifically exempt IRAs from creditor claims during bankruptcy. However, Title 11, Section 522(d)(10)(E) of the U.S. Code states that a debtor in the midst of bankruptcy retains the right to receive pension, annuity, profit-sharing and stock-bonus payments, along with payments from similar plans.
In the 1992 Supreme Court case, Patterson v. Shumate, the court determined that Section 522(d) protects qualified retirement funds during bankruptcy. Each U.S. state interpreted the ruling differently -- many providing state protections for IRAs during bankruptcy. However, in 2005, the Supreme Court further ruled that IRAs qualify for consistent protection from seizure in bankruptcy in every U.S. state. The same year, Congress approved the Bankruptcy Abuse Prevention and Consumer Protection Act, which limited bankruptcy IRA protection to $1 million.
Some types of creditors hold the right to IRA and other otherwise exempt retirement-savings accounts. For example, bankruptcy provides no protection for the assets from the IRS for unpaid taxes, nor does it protect retirement funds from garnishment in order to recover alimony or child-support delinquencies.
While federal law protects the money inside an IRA during bankruptcy, it does nothing for distributions from the account. Once the money leaves the account, the law provides no further bankruptcy protection unless the debtor repays the money within 60 days of the initial withdrawal. For example, a retiree who takes annual IRA distributions must include the distribution amounts as income during bankruptcy. The court reserves the right to redistribute disposable amounts of that income for debt repayment.
Debtors should think twice before contributing a large sum of cash to an IRA with the intention of sheltering assets from seizure in bankruptcy. The bankruptcy court may deem a cash transfer to an IRA in anticipation of bankruptcy as fraudulent or preferential over repaying creditors. In such cases, the bankruptcy trustee has the right to reverse the contribution to help repay bankruptcy debts. However, if a debtor has a history of consistent IRA contributions and the contributions he makes prior to bankruptcy mirror previous contributions, the court may be less likely to seize recent deposits.
- Cornell University Law School: United States Code - Section 522 Exemptions
- Entrepreneur.com; "Court Ruling Protects IRAs in Bankruptcy"; Sidney Kess; June-July 2005
- USA Today; "Supreme Court Rules IRAs Exempt from Bankruptcy Proceedings"; Joan Biskupic; April 4, 2005
- Bankruptcy Law Network; "Can I Make A Maximum IRA Contribution To Protect My Cash?"; L. Jed Berliner, Bankruptcy Attorney
- Jupiterimages/Photos.com/Getty Images