Protecting IRA Accounts from Bankruptcy

The much touted Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has a silver lining that extends the bankruptcy protections enjoyed by employment-sponsored retirement plans, which are covered by the Employment Retirement Income Security Act (ERISA). Congress designed the law to curb perceived abuses by debtors in bankruptcy.

Essentially, the act declares assets held inside retirement plans that are exempt from federal income tax are now exempt from the bankruptcy estate. This covers qualified retirement plans such as 401(k)s, 403(b)s, IRAs, Roth IRAs, governmental plans and tax-exempt organization plans. The real catch is that this protection only applies to bankruptcies. It does not extend to other judgments the way federal law (specifically ERISA) now protects qualified plans.

Like most rules pertaining to IRAs, there are limitations, and in this instance, the limit is $1 million of protection. However, looking at the math behind the limits, it seems unlikely for an account to reach that mark. Consider this example: if you had contributed the maximum to an IRA each year from when they began in 1975 to 2005 (when the law went into effect), you would have made contributions in excess of $63,000 (more than $65,000, if you qualified for the over age 50 catch-up provision, which began in 2002). In order for this example to exceed the limitation of $1 million, the IRA would have had to earn at least 13% each year for 30 years. Even then, only the portion above $1 million is unprotected. This protection limit is adjusted for inflation, thus further reducing the chance of exceeding the maximum. As long as the assets remain inside the IRA, they are protected. However, when the money is distributed, it is no longer shielded form bankruptcy (including required minimum distributions).

Once again, it is easy to see why proper planning—when it comes to finance—is essential to reaching the endgame. Even in a bankruptcy situation, a little planning can do much in the way toward starting over.

For more information, please contact Henssler Financial at 770-429-9166, or experts@henssler.com.

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