Although relief available through the Paycheck Protection Program (PPP) and the CARES Act may have kept them afloat for a while, many businesses and individual investors continue to experience the economic fallout caused by the pandemic.
Chapter 11 filings were up about 20 percent in February 2021 over the same month in 2020, and because bankruptcy filings lag behind other signs of economic distress, experts predict the worst may be yet to come.
If you’re considering filing for bankruptcy, it’s natural to be concerned about your retirement accounts. In particular, you may be wondering about your Roth IRA bankruptcy protection.
Before 2005, certain retirement assets—including traditional and Roth IRAs—had some protections at the state level, but these protections varied from state to state. However, after President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, the federal government now protects the IRA assets of all U.S. citizens.
Under BAPCPA, the following retirement savings accounts are generally excluded from bankruptcy:
As you can see, only IRA assets have a dollar limit for their bankruptcy protection. This amount, which applies to traditional and Roth IRAs, was set in April 2019 and will be adjusted for inflation in 2022 and beyond.
Both types of IRAs (traditional and Roth) offer tax advantages. The key difference between a Roth IRA and a traditional IRA is the timing of when you claim those advantages. With a traditional IRA, you take out contributions now and then pay taxes later. With a Roth IRA, you pay taxes on contributions now and then take out tax-free withdrawals later.
If you have rollover assets combined with your IRA contributory assets, and your IRA account balances are approaching the $1,362,800 limit, you may need to provide documentation showing how much of your IRA balances come from employer retirement plan savings.
Each state can still create additional laws regarding the types of property that may be protected from creditors, such as a home or a vehicle. And, in some states, people filing for bankruptcy have the option to choose between following the federal laws or the state laws regarding exclusions of personal property, depending on which one is more favorable.
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While BAPCPA does not offer creditor protection for Roth and traditional IRAs accounts above the current $1,362,800 limit, a bankruptcy judge has the authority to extend the protection if they believe your situation warrants it.
Under the terms of BAPCPA, a rollover IRA is either a Roth IRA or a traditional IRA that was funded initially by a qualified retirement plan. These “qualified” plans, including traditional pension plans, standard 401(k) plans, and some employee profit-sharing plans, are shielded from creditors in a bankruptcy.
To make sure that a rollover IRA from an employer-sponsored retirement plan has full protection, it’s a wise idea to create a separate account just for those assets. With separate accounts, the origin of the assets is easy to document in a bankruptcy proceeding.
In a 2014 decision -- Clark v. Rameker -- the Supreme Court unanimously ruled that inherited IRAs should not have the same level of creditor protection as retirement plans under federal bankruptcy law.
The Supreme Court’s decision seems to be limited to IRAs inherited by someone other than a spouse. There are special tax code rules for spousal beneficiaries, including the ability for a surviving spouse to roll over the inherited IRA into their own IRA.
However, Clark v Rameker applies to Self-Directed IRAs (both the Roth and traditional varieties). A Self-Directed IRA is an account that does not have a “custodian,” meaning account holders are able to invest in “non-traditional” assets, such as real estate, precious metals, and renewable energy.
The court gave the following as reasons for the ruling:
It’s important to note that after an IRA is inherited by a beneficiary other than a spouse, the law sees the account in the same way as all other assets when it comes to creditor protection. That means that a creditor may be able to may obtain a judgment and a court order to seize a Self-Directed Inherited IRA.
However, as we noted earlier, some states give debtors a choice between handling their bankruptcies under federal or state guidelines. It’s worth finding out how your state stands on the issue since some states offer exemptions that are more favorable for Self-Directed Inherited IRAs and account holders with IRA balances over the dollar limit.
Parents of adult children who are spendthrifts or who are facing legal issues may want to set up a trust rather than passing their IRAs directly on to their children where, depending on their state, they may be seized by creditors.
No one wants to think about bankruptcy, but this past year has thrown us some challenging circumstances. While many employer-sponsored retirement accounts are protected from creditors, it will put your mind at each to know for sure.
If you still have questions, speak with your plan administrator or your financial advisor.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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