Retirement Accounts – Which Ones Are Protected in Bankruptcy?
Knowing the Bankruptcy Rules Can Help Protect Your Assets From Your Creditors
When employees who have contributed to their employer’s 401(k) or 403(b) retirement plans leave their place of employment, they are often faced with this major financial decision.
“Do I leave my retirement funds in my (former) employer’s 401(k) plan, roll those funds into my new employer’s 401(k) plan, or roll the funds into a new or existing IRA?” Factors that may impact your decision are that the former employer may not allow you to maintain your retirement funds in your old 401(k) plan and the new employer may not allow those monies to be rolled over into the new employer’s retirement funds. There are also investment factors such as the diversity of investment options within the different employer plans, the historical performance of the different plans, accessibility to those monies, etc.
When making such a major financial decision, you should FIRST consult with your advisers . . . your financial investment adviser and tax professional, at a minimum.
Many people mistakenly believe that all retirement funds are 100% protected from claimants in bankruptcy. That is not necessarily true. While we are speaking about bankruptcy, you may be thinking that bankruptcy is not of concern to you. Hopefully, it is not. But we have seen taxpayers in our office with very significant IRS tax debt problems who have either filed for bankruptcy or have at least considered it. Before finding themselves in financial distress, they too were never concerned about bankruptcy.
It is our non-legal understanding that employer-held pension, 401(k) and 403 (b) accounts are 100% protected in bankruptcy. If bankruptcy is of concern to you, you need to consult with an experienced bankruptcy attorney.
However, the same protection does not hold true for IRA accounts you hold. Effective April 1, 2019, the inflation-adjusted cap on IRA bankruptcy protection will increase to $1,362,800 (up from $1,283,025). This cap applies only to IRA or Roth IRA contributions and earnings on those funds. It does not apply to company retirement plans.
What if you were to roll 401(k) monies into your IRA account and the balance in that IRA account exceeded the $1,362,800 protection cap? Have you now exposed the funds in your IRA that exceed the IRA protection limit to your claimants?
There is good news. For purposes of the Bankruptcy Abuse Prevention and Consumer Protection Act, a rollover IRA is a traditional or Roth IRA account that was originally funded through a transfer from a qualified retirement plan. Qualified retirement plans include standard 401(k) plans, traditional pension plans and certain profit-sharing plans. Under BAPCPA, a properly executed rollover IRA (be sure to consult with your tax professional as to how to properly execute an IRA rollover) originating from a qualified retirement plan is fully shielded from creditors in a bankruptcy. The aforementioned ERISA protection continues even after the company plan assets are rolled into an IRA. Thus, it is possible to combine monies from former employers’ retirement plans with your IRA monies and have those funds protected in bankruptcy.
It is very important to maintain accurate and complete financial records when ERISA monies are combined with IRA monies to prevent an issue in bankruptcy. The burden is on the person filing for bankruptcy to delineate between IRA contributions/earnings and his 401(k) rollover dollars. If the IRA owner was very successful with his IRA investments and his/her IRA contributions and earnings began to creep toward (or exceed) the new $1.362 million cap, it would be important for the account holder to understand his potential bankruptcy exposure if supporting documents could not support the separation of ERISA and IRA monies.
Since maintaining records can be a challenge to some individuals, an easier course of action may be to maintain two IRAs – one for IRA contributions and earnings – and the other for the ERISA 401(k) rollover dollars to an IRA.
While the maintenance of separate accounts is not explicitly required under law, it helps to avoid potential issues during a bankruptcy proceeding. With separate accounts, the origin of assets is easy to document and the asset pools are easy to track for purposes of securing all available bankruptcy protections.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.