On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The new law, which goes into effect on October 17, 2005, generally makes it tougher for people to protect their assets in the event of personal bankruptcy. But there's one notable exception: IRAs, fast becoming the biggest asset people have, actually receive more protection under the new law.
Under the new law, up to $1 million of the assets you hold in traditional IRAs and Roth IRAs, or a larger amount determined by the bankruptcy court, will be exempt from your bankruptcy estate.
What's more, IRA assets that came from an employer retirement plan rollover--such as a 401(k), 403(b) or profit-sharing plan--won't be subject to the claims of your creditors, regardless of the state in which you reside or the value of your rollover assets and their subsequent growth.
The new law also reinforces the unlimited protection that currently exists for 401(k) plans, 457 plans, 403(b) plans, governmental plans and tax-exempt organization retirement plans, and adds to the list of exemptions from the bankruptcy estate plans for the small business and/or self-employed person, including SEP-IRAs, SIMPLE IRAs, Keogh plans and solo 401(k) plans. (Given unlimited bankruptcy creditor protection, such retirement accounts are likely to become even more attractive retirement-savings vehicles in years to come.)
In addition, retirement funds in transit from one IRA or retirement account to another are also protected under the new bankruptcy law. The law even provides protection if you withdraw funds from an IRA and roll them back over within 60 days into an IRA or other retirement account.
But you should know that not all facets of IRAs are protected. For instance, distributions from retirement plans--required minimum distributions and hardship distributions--aren't protected under BAPCPA. So once you've withdrawn money from a plan, it's no longer protected.
Furthermore, the new law provides greater creditor protection for IRA assets, but only in bankruptcy. So they don't apply to judgments awarded in other courts where state creditor protection laws will apply. And BAPCPA won't stop a divorcing spouse from being able to take a share of the other spouse's pension.
So what are the implications of the new law? First, the new law creates clarity where there had been confusion stemming from a lack of conformity among the states. Prior to BAPCPA, it was difficult to determine how a person's IRA would be exempt from the claims of his or her creditors if they filed for personal bankruptcy. Now that's no longer the case.
Under the new law, investors have the incentive to keep IRAs that are funded with rollover salary-deferral contributions separate from IRAs funded with annual contributions. To co-mingle rollover and contributory IRA assets would make it difficult to identify which portion of the IRA represented assets that are "unlimited protection" rollovers (plus earnings) and which portion represented IRA contributions and earnings (subject to the $1 million limitation).
The new law also encourages investors to roll over their 401(k) to an IRA after they're no longer employed. Prior to BAPCPA, investors often left their funds in their former employer's 401(k) plan since such plans were fully protected from bankruptcy. Now that 401(k) plans and IRAs have near equal protection from creditor claims, there's less reason to leave such funds behind.
On the other hand, one good reason to leave assets in a 401(k) or other former employer plan is that qualified retirement plans are protected under the Employee Retirement Income Security Act (ERISA), which extends to judgments other than bankruptcy, regardless of your state law.
Like all new laws, BAPCPA will likely be challenged by creditors at some point in the courts. So before making any changes to your IRA's current status, I'd suggest you seek the advice of your certified financial planner and a bankruptcy attorney who can advise you as to your best options.
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Debra Neiman, CFP, is principal of Neiman & Associates Financial Services, a financial planning firm and registered investment advisor in Watertown, Massachusetts. She's also the co-author of the recently released book, Money Without Matrimony: The Unmarried Couple's Guide to Financial Security.