Protecting Your Retirement from Creditors and Divorce
As part of the bankruptcy law overhaul in 2005, Congress exempted retirement plans and pensions from claims by creditors, meaning that even if you have to declare bankruptcy, you will not have to forfeit your 401(k) and IRA plans if you are sued – one more reason to sock away as much money as possible into your retirement plans. There is no limit on the amount in your employment related retirement plans you can protect or in such plans rolled over into IRAs.
However, the creditor protection for your own IRAs or Roth IRAs is limited to $1,283,025 (in 2016). It’s not clear what happens if you mix rolled-over retirement funds with an existing personal IRA, whether the IRA limitation will apply to all of the funds. So, beware rolling over an employment-related retirement plan into your personal IRA if you have enough set aside so that the limitation is relevant. If not, that’s not a concern.
While your own retirement plans qualify for this protection, the US Supreme Court in Clark v. Rameker in 2014 ruled that these protections do not apply to inherited IRAs. So, if you inherited an IRA from your mother, it will not be protected in your bankruptcy proceeding. If, on the other hand, you inherited it from your wife, then you can protect it by converting it to your own IRA (up to the limit cited above). If you think that one of your heirs may run into bankruptcy issues, consider naming a trust as beneficiary rather than him. If properly-drafted, a trust will protect inherited IRAs from creditors, as well as prevent your heir from withdrawing the funds too soon and pay unnecessary taxes. But the trust must be drafted in the right way to hold IRAs.
Most of these creditor protections for retirement plans do not protect the funds in the event of divorce or in the event the owner needs to qualify for public benefits. In some states, certain retirement plans are not counted in determining eligibility for Medicaid, but the rules are different from state to state. In the event of divorce, they will almost always be included in the pool of assets to be divided. This is not the case for a trust holding an inherited IRA. Such a trust can protect the IRA in the event of divorce, from being counted for eligibility for public benefits, and from creditors.