Pending bankruptcy legislation would protect IRAs
No matter what side of the fence you're on when
it comes to the pending Bankruptcy Reform Act legislation, one major
benefit that's likely to come from its passage
is protection -- to some extent -- for IRAs from creditors should
you file for bankruptcy.
ERISA -- Employee Retirement
Income Security Act -- is the federal law that protects 401(k) and
pension plans from creditors in most cases. Exceptions include a
federal tax lien against you or if a former spouse is entitled to
some of your benefits.
But IRA protection is left
up to the states -- and it's a mishmash of laws. Most states safeguard
traditional IRAs, but many don't afford the same protection to Roth
That means if you file for
bankruptcy before the federal law passes, your IRA or Roth retirement
fund could be grabbed by creditors, depending on the state where
you live. Yet, some states will safeguard your horse and buggy from
"States for some reason have been very lax about
updating property exemptions," according to Todd Zywicki, law professor
and bankruptcy expert at George Mason University in Arlington, Va.
"California is one that regularly updates its list of property that's
exempt, but a lot of states don't.
"You'd think New York would be very progressive,
yet it still has turn of the century exemption rules -- all stoves
with the necessary fuel for 60 days, one sewing machine. Clearly,
protecting IRAs should be a state policy."
Professor Charles Tabb, bankruptcy expert at
the University of Illinois College of Law in Champaign, Ill., says
it's always been a bit curious to him that the states have been
in charge of deciding whether IRAs are exempt from bankruptcy.
"The ability to make an entitlement, such as
an IRA, is federal law. It's odd that Congress gives that right
to people and then punts back to the states. There's been a lot
of litigation on whether it's even a legitimate thing for Congress
to allow the states to make the call when IRAs are controlled under
Pending protection reforms
The Bankruptcy Reform Act -- in its current reincarnation -- would
protect up to $1 million in IRAs, including Roths, from creditors.
"You would think that protecting retirement
accounts would be very compelling public policy," says Zywicki.
"It's consistent with the trend to encourage private savings; especially
since the states aren't acting in a uniform manner."
Bankruptcy attorney James Caher of Eugene, Ore.,
dislikes many of the provisions in the Bankruptcy Reform Act, but
says the IRA protection is good.
"It's just good policy that older Americans
should have some sort of retirement plan and a place to live. Unless
you have clear issues of fraud or abuse -- borrowing a bunch of
money and trying to protect it in a retirement plan. Going after
pensions and homesteads is how the credit industry thinks it will
get bailed out of this foolish lending they've done."
Caher says a blanket federal law protecting
IRAs is needed and until protection was established under Oregon
law, he advised against clients setting up a Roth IRA, which has
the least protection of all IRAs other than Education IRAs.
"Until the legislation fixed this, I was warning
people not to do Roth IRAs. If bankruptcy is in your future, don't
do a rollover or take a distribution without talking to a bankruptcy
Millions of Americans have set up rollover IRAs
and Roths without giving a second thought about whether they'd be
shielded from creditors. Most people assume they'll never file for
bankruptcy, and if they do, they probably think their retirement
accounts are safe.
Unless we have assets that are significantly
higher than our debts, any of us could find ourselves quickly overwhelmed
by bills if we lost our jobs or got wiped out by divorce or medical
bills. Couple that with the fact that many people are pumping money
into Roths for its tax benefits and you have a financial disaster
if your state doesn't protect Roths or regular IRAs.
Experts say many states seem hesitant to exempt
Roths because federal law protects deductible contributions,
and Roth contributions are nondeductible. Another often-debated issue
is whether protection should be afforded to IRAs that aren't employer-sponsored.
Employer-sponsored IRAs are the SEP IRA and the Simple IRA.
State laws regarding IRA protection are so varied and change so
rapidly that the best way to find out how you're protected is to
check with a bankruptcy attorney or your state legislature. Be very
specific about the type of IRA you have -- traditional, rollover,
But even in states that do protect IRAs, statutory
exemptions don't always keep creditors from going after IRAs. There
are numerous cases where creditors try to claim that a particular
debtor's IRA isn't covered by the statutory exemption for various
A blanket federal law would likely correct all
Zywicki says the current version of the Reform
bill would not allow money borrowed against a retirement plan to
be deductible in a bankruptcy.
"Right now you can borrow against your retirement
savings and discharge that loan in bankruptcy court, as long as
there was no fraudulent attempt when you took out the loan," says
The new bill protects money put into an Education
IRA at least one year before filing for bankruptcy. Zywicki says
there are no similar restrictions for Roths or regular IRAs.
The Bankruptcy Reform Act is being spiffed up
in a House-Senate conference committee. Zywicki says both versions
are pretty similar, and he expects it to pass by the end of the
-- Posted: Aug. 29, 2001