Protecting Your Retirement Assets

INTRODUCTION

When attempting to protect your retirement assets, such as whether to roll over a 401(k) to an IRA, there are two separate asset protection issues to consider:  1) Bankruptcy, and 2) proceedings under state law such as attachment, garnishment, and insolvency.  The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) provides more uniformity among the state in bankruptcy, but does not affect any non-Bankruptcy proceedings under state law.

Employer sponsored retirement plans covered by ERISA (such as 401(k), 403(b)) enjoy the most protection in both bankruptcy and under state garnishment and attachment proceedings.  Individually funded IRA’s depend on the state law of the individual, but may enjoy some degree of protection in bankruptcy (under either state law or under the new federal bankruptcy law) and some protection from attachment and garnishment actions.   SEP’s are Simple IRA’s the least protected of all, as discussed herein.

BANKRUPTCY

Retirement Plans.  In 2005, BAPCPA clarified the rights of debtors relating to their retirement assets when a filing for bankruptcy.  Section 522(d)(12)) of the Bankruptcy Code now gives unlimited protection in bankruptcy to any fund that is tax-exempt under IRC sections 401, 403, 408 (with limits) 414, 457 and 501(a)), by excluding them from the federal bankruptcy estate. 

Rollover IRA’s.    1) BAPCPA allows an unlimited exemption in bankruptcy to rollovers from most employer sponsored Retirement Plans.  (Bankruptcy Code Sec. 522(n)).

     2) BAPCPA allows only a $1,095,000 exemption (adjusted for inflation) in bankruptcy for a rollover from SEP or SIMPLE IRA.  (Bankruptcy Code Sec. 522(n) does not sanction Sec. 408(d)(3) rollovers).

SEP’s, SIMPLE IRA, & Individual IRA’s.  IRA’s are governed by Sec. 408 of the Internal Revenue Code.  BAPCPA limits the exclusion for individual IRAs and Roth IRAs to $1,095,000 (adjusted for inflation)(Bankruptcy Code Sec 522(n)).  SEP IRA’s or SIMPLE IRA’S are excluded completely without limitation. 

STATE INSOLVENECY, ATTACHEMENT & GARNISHMENT

Retirement Plans.  The new Bankruptcy Act does not address debtor's retirement funds that are involved in a state law insolvency, attachment or garnishment proceeding.  Such a proceeding is controlled instead by a compilation of ERISA, case law and state statutory law.   ERISA contains extensive provisions that protect employer sponsored retirement plans from state actions such as garnishment and attachment (except for SEP’s and Simple IRA’s as discussed below).

CAUTION:  In most all states, retirement funds can be attached through qualified domestic relations orders and federal and state tax liens in or outside of a bankruptcy.

CAUTION:  Owner and Spouse Only Plans.  Under case law and Department of Labor regulations, a plan that benefits only an owner and his or her spouse is not an ERISA plan, and so does not qualify for anti-alienation protections under Title 1 of ERISA.  Such plans are not at risk in bankruptcy proceedings due to BAPCA, but could be at risk in a state attachment/garnishment proceeding.

SEP and Simple IRA’s.  Employer-sponsored SEP and SIMPLE IRAs are the most exposed type of retirement asset because they are NOT protected under ERISA nor applicable state laws.  This is due to a quirk in the ERISA provisions, as further discussed below:   

·       Anti-Alienation.  SEP and SIMPLE IRA’s are NOT protected from attachment and garnishment by ERISA, even though they are “ERISA Pension Plans.”

·       Preemption.  ERISA preempts state law protections that would otherwise be afforded to ERISA pension plans (ERISA section 514(a)). 

SEP and SIMPLE IRA’s therefore are at risk in state garnishment and attachment actions.  This is exactly what happened in the 6^th Circuit Court of appeals case Lampkins v. Golden 2002 WL 74449 (6^th Cir. Mich. 2002).  In that case the court held that 1) a SEP was not covered by ERISA’s anti-alienation provisions, and 2) Michigan’s state statute that exempts garnishment of individual retirement accounts was preempted by ERISA, and thus the SEP was subject to garnishment.  Because Tennessee is in the 6^th Circuit, this would affect TN residents.

Individual IRA’s.  An individually established and funded traditional or Roth IRA is not an ERISA pension plan, and therefore should not pre-empted by ERISA.   State laws can therefore protect individual IRA’s (but not SEP or Simple IRA’s).  The Lampkins case referenced above caused many commentators to fear that all IRA’s would be unprotected under state statutes, due to preemption by ERISA.  However, the Lampkins case dealt only with a SEP IRA and is therefore factually distinguishable from an individual IRA. 

Rausey.  A U.S. Supreme Court case, Rausey v. Jacoway, 125 S.CT. 1561 (2005) also caused some concerns as to whether IRA’s would be protected after the IRS imposed withdrawal penalties were removed when a person reaches 59 ½.  Because there were no Arkansas law protections in place here, the debtor had to create a new theory for protection.  This case is therefore not relevant and necessary for states such as TN and MS that grant protection to IRAs.  Furthermore, Rousey pre-dated the 2005 new bankruptcy law and is now largely irrelevant for bankruptcy, due to the increased $1M protection granted IRA’s and unlimited protection granted to rollover IRA’s by the 2005 bankruptcy act.   

State of Residencey.  Because ERISA does not preempt individual IRA’s, the owner's state of residency determines whether the IRA is protected.  Tennessee law specifically exempts both traditional and Roth IRAs from execution, garnishment, attachment or sale to satisfy a judgment or order, by anyone other than state of Tennessee (T.C.A. 26-2-105).  Mississippi exempts regular IRA’s under M.C.A. 85-3-1(e), but it is unclear if Roth IRA’s are protected.  An Arkansas statute grants $20,000 of protection but was ruled unconstitutional in In re holt, 894 F.2d 1005 (8^th Cir 1990), so there is likely no protection of IRA’s outside bankruptcy in Arkansas.

CAUTION:  Because the domicile of the debtor controls what state law applies, it is possible for a Tennessee resident to rollover their 401k to an IRA that would be 100% from protected attachment in Tennessee, but later move to a state where it the IRA is not protected.

Rollover IRA’s.  Assets rolled over from a SEP or SIMPLE IRA into a rollover IRA are not part of an employer maintained arrangement and therefore would not be characterized as parts of an ERISA pension plan.  The rolled over assets would not then be subject to ERISA preemption and could take advantage of any state law protections, as a rollover IRA.

By:   C. Michael Adams, Jr, CPA, LLM,  2010