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"Does Creditor Protection Factor Into Rolling Over a 401(k) Into an IRA?" by Julie Jason

Originally published: Dec. 9, 2022 (distributed by Andrews McMeel Syndication)

A Connecticut 401(k) participant wants to know if she should avoid rolling over her 401(k) to an individual retirement account (IRA) because 401(k)s are protected from claims of creditors. If she does a rollover to an IRA, will she lose creditor protection? 

     That's a question that is most relevant to individuals who are fearful of being sued. The answer may depend on the state you live in. For example, in my home state, Connecticut, creditor protection extends to both IRAs and 401(k)s. That is not the case in all states. 

     But even in other states, there may be IRA protection in the case of bankruptcy, as I'll explain with the help of tax expert attorney Edward A. Renn of Withers Bergman LLP (tinyurl.com/2s3u2ded). Renn advises ultra-high-net-worth individuals on tax, estate planning and other private client concerns. Withers is an international law firm with offices in Connecticut, New York, London, Geneva, Singapore and other places. 

     We'll talk about two federal laws first, then state laws. 

     -- ERISA. There is a federal statute (ERISA -- the Employee Retirement Income Security Act of 1974) that protects retirement plans such as 401(k)s against claims of creditors. The exceptions are spouses who have a right to claim 401(k) assets through the courts (for example, in the case of a divorce). Another exception is a claim by the federal government. 

     ERISA does not extend its protections to IRAs. 

     -- Bankruptcy. A federal bankruptcy statute (the Bankruptcy Abuse Prevention and Consumer Protection Act (BABCPA)) does protect IRAs from creditors, no matter what state an account holder may live in. 

     To benefit, you have to file bankruptcy. 

     Protection for rollover IRAs is unlimited in dollar amount. (Rollover IRAs are funded with rollovers or transfers from qualified plans, such as 401(k)s.) Protection for IRAs that you yourself funded (contributory IRAs) is capped at approximately $1.5 million. The cap is due to increase in 2025 for cost-of-living adjustments. 

     That's good reason to set up a new rollover IRA account for accepting 401(k) rollover assets, instead of using an existing an IRA that you funded yourself. 

     -- States. Certain states, such as Connecticut, address IRA creditor protection by statute. 

     The Connecticut statute protecting IRAs from creditors is Section 52-321(a) of the Connecticut General Statutes. Protection is not limited in dollar amount. 

     In Connecticut, protection extends to owners of IRAs whether the IRA is set up to receive the rollover from the 401(k) or the IRA is one that you set up with your own contributions. 

     The exceptions are qualified domestic relations orders (QDROs); recovery of costs of incarceration; and recovery of damages by a victim of crime (tinyurl.com/mrm2kawu). 

     In other states that offer protection, there may be a dollar limit. For example, in Maine, the dollar amount protected is limited to $15,000. In California, the dollar amount protected is subject to court review of the debtor's situation. 

     If you are concerned about potential creditor claims against your IRA, you do need to know the rules of your state. Make sure to seek legal counsel specialized in this area of the law. Your 401(k) will be protected in all states. 

     On another note, people seeking asset protection for other assets will likely come across international asset protection trusts. 

     "The asset protection trust industry was born from doctors who couldn't get enough malpractice insurance," according to attorney Blake Harris of Blake Harris Law (blakeharrislaw.com). The primary jurisdiction from such trusts is the Cook Islands, located in the South Pacific. 

     Asset protection trusts are for protection against lawsuits, explained Harris, not for evading taxes. 

To read Julie Jason's books, go to: https://juliejason.com/author/julies-books.