If you are facing financial straits and have a nest egg of a retirement to consider, bankruptcy can be filed to shield IRA assets from creditors. Qualified retirement plans such as employer-sponsored plans like 401(k)s and 403(b)s are afforded protection under ERISA; therefore, they are not part of the bankruptcy estate and are also protected from other types of judgments.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, commonly referred to as BAPCA, extended these same type of ERISA protections to IRA's and certain other investment products in a bankruptcy proceeding.
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So what does this mean for the investor? IRA investors now are even shielded further against creditors than they were before BAPCA. It is common in today's job market for the average worker to change jobs numerous times during a career, resulting in many 'orphan' IRAs that the investor thereby ends up consolidating into a single IRA. So, fear not your portable nature and the investment behavior that led to an IRA consolidation. BAPCA is here to save the day.
The following are the protections that a bankruptcy filer will be afforded in regards to their IRA investments:
Section 522 of the Bankruptcy Code states, in relevant part:
(n) For assets in individual retirement accounts described in section 408 or 408A of the Internal Revenue Code of 1986, other than a simplified employee pension under section 408(k) of such Code or a simple retirement account under section 408(p) of such Code, the aggregate value of such assets exempted under this section, without regard to amounts attributable to rollover contributions under section 402(c), 402(e)(6), 403(a)(4), 403(a)(5), and 403(b)(8) of the Internal Revenue Code of 1986, and earnings thereon, shall not exceed $1,000,000 in a case filed by a debtor who is an individual, except that such amount may be increased if the interests of justice so require.
In layman's terms this adds up to the following protections for IRA investments:
o Note that I will mention that certain property is either excluded from the bankruptcy estate altogether, or exempt under federal and/or state law. In either case (exclusion or exemption), the asset remains protected from creditors.
o How much will the bankruptcy umbrella protect and what is protected? All retirement funds exempt from taxation under Sections 401, 403, 408, 408A, 414, 457 and 501 of the federal tax code are now protected from the reach of creditors. Contributory and Roth IRA assets are capped at an amount of $1 million (inflation adjusted). Therefore, there is $1 million cap on the IRA investment amounts. Because of IRA's fairly recent inception (1974) and a $2,000 cap on contribution that was in place until 2002, its safe to say that the $1 million cap should provide a big enough umbrella for today's IRA investors.
o Now read in Section 522 the language stating, "without regard to amounts attributable to rollover contributions." This means that rollover IRA's are exempted in bankruptcy, thus allowing qualified retirement plan assets that are rolled over to an IRA to exceed the $1 million limit that's in place for contributory or Roth IRA assets. Therefore, 'roll over strategy' should be discussed with your attorney to provide maximum protection in bankruptcy. Now read the language stating, "except that such amount may be increased if the interests of justice so require." This is once again referring to the $1 million dollar cap. This leaves the court with a lot of wiggle room and may not be a reliable legal crutch. I would advise seeking counsel in the bankruptcy vicinage which you will be filing, to see what of protection can be expected in that district.
o Whereby ERISA failed to protect the independent IRA investor, BAPCA saves the day. BAPCA provides welcome protection for sole proprietors who typically invest in Keogh and/or 401(k) plans.
o BAPCA was also written to include Simplified Employee Plan (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) IRA's. These IRA investments are excluded and are protected for unlimited amounts.
o Money that you have put away for your children's education in protected under BAPCA. Coverdell Education Savings Accounts (ESA) and state-sponsored Section 529 college savings programs are included. Any contributions made to these products for a child, grandchild, stepchild, or step-grandchild more than two years before the filing are protected. Those monies contributed more than 365 days but less than 720 days before the bankruptcy filing are protected only up to $5,000 per beneficiary.
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