Are Your Retirement Benefits Safe From Creditors?

Estate Planner Mar-Apr 2001
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Maintaining a qualified retirement plan, such as a 401(k), offers long-term security. But how safe are these assets if you are subject to claims before retirement? The Internal Revenue Code specifically bars qualified plan benefits from being assigned or alienated except under certain circumstances. The U.S. Supreme Court has taken this further, conclusively holding that ERISA qualified plan benefits are absolutely protected from creditors (including in bankruptcy) other than the IRS, spouses and ex-spouses under qualified domestic relations orders. Nonetheless, several questions come to mind.

Are IRAs Protected? 

Upon retirement, retirees commonly roll over 401(k) and other qualified plan assets into individual retirement accounts (IRAs). But the protection for assets held in such nonqualified plans is unclear. Federal law does not expressly protect them, though many states have enacted statutes that do.

Are Distributions Protected? 

Whether a plan distribution is protected from creditors primarily depends on state law, and, as with IRAs, the protection afforded varies widely. Many states give some level
of protection to segregated funds that consist only of the amount necessary to support the debtor.

Other states rely on federal law. Federal bankruptcy exemptions apply to distributions reasonably needed to support a plan beneficiary. But it is unclear whether the debtor must already be receiving payments to take advantage of the exemption. Clearly unprotected are amounts in excess of what is reasonably necessary for support.
Unfortunately, federal law mandates when distributions must begin and how much must be taken. If creditors are an issue, hold off taking distributions as long as possible.

Are Funds Contributed Shortly Before Filing Bankruptcy Protected? 

The fraudulent conveyance rules bar giving assets away to avoid paying a creditor. Conversion of assets that are not protected into assets that are, such as contributing funds to a 401(k) shortly before filing bankruptcy, should not, strictly speaking, be a fraudulent conveyance.

But a prefiling contribution doesn’t look good, particularly if the timing of the contribution is unusual for the debtor. A bankruptcy trustee can refuse a discharge order for a debtor who has engaged in transactions that appear to impede a creditor’s rights.

Smart and Effective

Maximizing contributions to plans continues to be one of the most effective retirement savings and asset protection devices available. Despite uncertainties, the potential benefit appears to outweigh the risk. If you have any questions about the security of your plan please call us. We would be glad to help you assess your accounts and advise you on ways to scrutinize the risk of loss
to creditors.