How Safe Are My Retirement Accounts, Really?
Q: I have a very successful small business. My wife and I are the only employees. Over the years, we have been blessed to save a significant amount of money in our retirement accounts (SEP IRAs, Roth IRAs and solo 401(k) plan). Much of our net worth is tied up in those accounts. I’m not worried about bankruptcy at this point, but I am worried about protection from other potential creditors, particularly lawsuits. How safe are my retirement accounts, really?
A: In today’s lawsuit-happy world, anyone with significant assets needs to be very careful about protecting themselves and their loved-ones. If you haven’t already done so, you should seek out a trusted and competent attorney who can look over your situation and help you better understand the specific legal risks you face. A little preparation now can save you a lot of grief later in the event someone tries to raid your “deep pockets.”
Beyond the tax advantages, one of the greatest benefits of retirement plans is the protection they provide you in the event of bankruptcy or legal judgments. Most employer-sponsored retirement plans are covered by ERISA—the Employee Retirement Income Security Act. Because of ERISA’s anti-alienation provisions, ERISA-covered retirement plans have unlimited protection in bankruptcy proceedings. ERISA plans include 401(k) plans, 403(b) plans, and SEP and SIMPLE IRAs.
Traditional and Roth IRAs are not ERISA plans, so they don’t have unlimited protection from bankruptcy. However, annual contributions to IRAs, and earnings on those contributions, are protected up to $1,283,025 (in 2018) in bankruptcy proceedings. This amount is adjusted for inflation every three years. The next adjustment will come on April 1, 2019. Money rolled into an IRA from an employer-sponsored plan, and the earnings on those funds, retain their ERISA bankruptcy protection even while they are in an IRA.
Inherited IRAs do not get this same protection in bankruptcy. In Clark v. Rameker, the Supreme Court decided that inherited IRAs are distinct from traditional and Roth IRAs in three fundamental ways: the holder cannot invest additional money into the inherited IRA, the holder must begin taking distributions, and the holder can take withdrawals at any time without penalty. Because of these differences, an inherited IRA may be subject to a bankruptcy judgment.
When it comes to protection from general creditors, non-ERISA accounts receive no protection from Federal Law. Therefore, if you have a summary judgment against you for some reason, your ERISA accounts (401(k)s and 403(b)s) will be fully protected, but your IRAs, Roth IRAs and even your SEP and SIMPLE IRAs will be at the mercy of state law. In California, this means a judge will decide how much you need for a reasonable standard of living in retirement. Whatever you may have beyond that amount is fair game to satisfy a judgment against you.
This is a particularly important consideration when you are considering rolling over an account from an ERISA-covered 401(k) or 403(b) plan to a non-ERISA IRA. The rollover IRA retains the ERISA-level bankruptcy protection, but loses the federal protection from general creditors.
Owner-only plans, such as your solo 401(k) plan, are a unique case. Department of Labor regulations clearly state that retirement plans that only benefit owners and their spouses are not covered under Title I of ERISA and therefore are not protected by ERISA’s anti-alienation provisions. However, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) opened the door for their protection from bankruptcy claims. Unfortunately, the BAPCPA protection does not extend to non-bankruptcy judgments, so the solo 401(k) owner is once again at the mercy of state law. In California, the amount of protection you receive will depend on how much the judge thinks you need to support your household in retirement.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.