What Is IRA Bankruptcy Protection?

Definition & Examples of IRA Bankruptcy Protection

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IRA bankruptcy protection is a provision made by Congress that allows individual retirement account (IRA) owners to protect their accounts from creditors in a bankruptcy proceeding. Whether you have a traditional IRA, a Roth IRA, or both, the federal government extends significant protection from creditors, within limits, in the event you declare bankruptcy.

If you think that personal bankruptcy is a real possibility in your future, understanding IRA bankruptcy protection can give you peace of mind about your retirement assets. Learn more about what's covered and what isn't.

What Is IRA Bankruptcy Protection?

IRA bankruptcy protection was signed into law by President George W. Bush under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). The act took steps to insulate non-employer-sponsored retirement funds from creditors by providing that the plans were excluded from "property of the estate." 

The passage of BAPCPA enabled for the first time protection for IRAs, including those rolled over from a 401(k) plan. Prior to the 2005 act, the only qualified retirement plans that received bankruptcy protection were 401(k) plans, pensions, and similar employer-sponsored retirement plans. Initial protection provided by BAPCPA was generally limited to $1 million.

How Does IRA Bankruptcy Protection Work?

IRA bankruptcy protection covers all types of IRAs: traditional IRAs, Roth IRAs, SEP-IRAs, SIMPLE IRAs, and rollover IRAs. In some cases, protection extends only up to a certain dollar amount, which increases regularly.

Here is a summary of IRA bankruptcy protection, according to the BAPCPA, based on the type of IRA:

  • Traditional IRAs and Roth IRAs: Historically, the limits on bankruptcy protection for these IRAs have been adjusted every three years. The adjustment in 2019 raised the limit to $1,362,800 from $1,283,025. The next increase will go into effect on April 1, 2022.
  • SEP-IRAs and SIMPLE IRAs: These IRAs are designed for self-employed individuals and small businesses. They receive the same protection as traditional IRAs and Roth IRAs, but there is no limit on the amount that is protected.
  • Rollover IRAs: BAPCPA identifies rollover IRAs as a traditional IRA or Roth IRA that was originally funded by a rollover transfer from an employer-sponsored retirement plan such as a traditional 401(k) or Roth 401(k). Like SEP and SIMPLE IRAs, protection on these accounts is not capped.

The bankruptcy protection limit placed on traditional and Roth IRAs covers the vast majority of account holders because the account balance maximum is higher than most IRA investors are likely to achieve through a combination of their contributions and the gains made on them during their working years. In addition, BAPCPA permits the protected amount to exceed the limit "if the interests of justice so require."

The cap on protection for traditional and Roth IRA accounts apples to the sum of all such accounts, not to each individual account.

What's Not Covered in IRA Bankruptcy Protection?

IRA bankruptcy protection is quite extensive, but some creditors can still claim assets in your IRA. The Internal Revenue Service (IRS) and an ex-spouse can take money from your IRA even after you have declared bankruptcy.

IRA Assets and the IRS

If you owe past taxes to the IRS, that federal agency can put a levy on your IRA, in addition to your paycheck. Generally, the IRS will put a levy on other assets before your IRA, but your retirement account assets are not off-limits to the agency.

IRA Assets and Divorce

Your ex-spouse can take assets from your IRA if a court order says they can. In fact, divorce is the only exception to the rule that an IRA account owner has to die before their assets can be transferred directly to someone else.

A court order may require the IRA's custodian to change the owner of the account to your ex-spouse if they are to receive all of the assets in it. Or the order may call for a portion of the assets in your account to be transferred to an account for your ex-spouse. In either case, the transfer is tax-free so long as it is carried out according to the terms of the court order.

Judgment Creditors Outside of Bankruptcy

Generally, there is no federal protection from creditors for IRA owners who have not filed for bankruptcy. Therefore, protection of your IRA from creditors who have court judgments against you depends on state law, which varies pretty widely.

For instance, in New York, IRA assets are protected from judgment creditors with few exceptions. A creditor may be able to take from you money you put into the IRA within 90 days before the creditor filed their ultimately successful claim against you. They also may be able to take money a court decides you put in the IRA for the express purpose of keeping it from them.

Final Thoughts

When it comes to IRA bankruptcy protection, certain federal rules apply. But if you are unsure whether your IRA assets are protected in your particular case, you may wish to seek legal counsel.

Key Takeaways

  • IRA bankruptcy protection is a federal law that protects your IRAs from creditors in the event you declare bankruptcy.
  • Roth and traditional IRAs are protected up to a certain limit, which changes every three years. SEP-IRAs, SIMPLE IRAs, and rollover IRAs are not subject to the limit.
  • There are still certain cases, such as divorce or the payment of back taxes to the IRS, in which your IRA may not be protected in bankruptcy.