Bankruptcy is not something most of us ever want to consider. But in uncertain times like these, it’s a reality some could soon be facing.
Federal bankruptcy law applies to all bankruptcies and provides some universal rules and protections for the individual filing for bankruptcy. For example, federal law generally precludes retirement savings from being accessible to creditors. Each state can create additional laws regarding the types of property that may be exempt from a bankruptcy estate (and protected from creditors), such as a home or a vehicle. In many states, bankruptcy filers may choose whether to follow the federal laws or the state law regarding exclusions of personal property, which may be more favorable.
Protection for Retirement Assets
- Under federal law, your retirement savings are generally excluded from your bankruptcy estate as follows:
- Employer-sponsored retirement plans (e.g., 401(k) and 403(b) plans) – unlimited amount
- Employer-sponsored SEP and SIMPLE IRA plans – unlimited amount
- Traditional and Roth IRAs – up to $1,362,800, as of April 1, 2019 (this level is adjusted every three years)
- Rollover IRAs (assets rolled from an employer-sponsored plan) – unlimited amount
Only your IRA assets are subject to an actual dollar limit for bankruptcy protection. This limit applies to all of your traditional and Roth IRAs in aggregate. If you have rollover assets comingled with your IRA contributory assets, and your IRA account balances are approaching the dollar limit, you may need to provide documentation to show how much of your IRA account balances are attributable to employer plan savings.
No Federal Protection for Inherited IRA Assets
The federal protection for retirement assets applies to individuals who have saved some of their income over the course of their working years to prepare for retirement. Historically, some bankruptcy courts extended this protection to IRAs held by beneficiaries who inherited retirement savings from the original owner of the account. Other courts treated inherited retirement assets differently and did not protect them. In 2014, the U.S. Supreme Court ruled in Clark v. Rameker that IRA assets inherited by a nonspouse beneficiary are not exempt from that beneficiary’s bankruptcy estate because the inherited IRA does not have the same legal characteristics for purposes of saving for retirement.
- A nonspouse beneficiary cannot make contributions to an inherited IRA.
- A nonspouse IRA beneficiary is forced to take distributions under the tax laws — regardless of how close to retirement he or she is.
- A nonspouse IRA beneficiary can take penalty-free distributions of inherited assets at any time and for any reason.
Spouse beneficiaries, on the other hand, may treat an inherited IRA as their own IRA, thereby changing the characteristics of the inherited assets to that of an IRA designed for saving for retirement.
State laws may be drafted to provide IRA beneficiaries greater protections in bankruptcy proceedings.
For More Information
If you’re considering bankruptcy, consult with your financial and legal advisors first to explore all available options for addressing financial challenges. If you have specific questions about filing bankruptcy, which assets may be excluded, and other protections from creditors, seek advice from an attorney specializing in bankruptcy law in your state.
For more information about your Mainstar Trust IRA, contact the Mainstar Trust team at 1-800-521-9897 or customerservice@mainstartrust.com.