What Is IRA Bankruptcy Protection?

How IRA Bankruptcy Protection Works

IRA bankruptcy protection was signed into law by President George W. Bush under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). The act took steps to insulate non-employer-sponsored retirement funds from creditors by providing that the plans were excluded from "property of the estate." 

The passage of BAPCPA enabled for the first time protection for IRAs, including those rolled over from a 401(k) plan. Prior to the 2005 act, the only qualified retirement plans that received bankruptcy protection were 401(k) plans, pensions, and similar employer-sponsored retirement plans. Initial protection provided by BAPCPA was generally limited to $1 million.

IRA bankruptcy protection is quite extensive, but some creditors can still claim assets in your IRA. The Internal Revenue Service (IRS) and an ex-spouse can take money from your IRA even after you have declared bankruptcy.

Example of IRA Bankruptcy Protection

For example, suppose you owe a great deal of money and you have declared bankruptcy. You have $500,000 in a 401(k) and $300,000 in a Roth IRA. Your 401(k) is protected during bankruptcy by the Employee Retirement Income Security Act of 1974 (ERISA), with no limit.

Thanks to BAPCPA, your IRA is also protected, up to the inflation-adjusted amount of $1,512,350.

IRA Assets and the IRS

However, there are some instances where your IRA is not protected.

If you owe past taxes to the IRS, that federal agency can put a levy on your IRA, in addition to your paycheck. Generally, the IRS will put a levy on other assets before your IRA, but your retirement account assets are not off-limits to the agency.

IRA Assets and Divorce

Your ex-spouse can take assets from your IRA if a court order says they can. In fact, divorce is the only exception to the rule that an IRA account owner has to die before their assets can be transferred directly to someone else.

A court order may require the IRA's custodian to change the owner of the account to your ex-spouse if they are to receive all of the assets in it. Or the order may call for a portion of the assets in your account to be transferred to an account for your ex-spouse. In either case, the transfer is tax-free so long as it is carried out according to the terms of the court order.

Judgment Creditors Outside of Bankruptcy

Generally, there is no federal protection from creditors for IRA owners who have not filed for bankruptcy. Therefore, protection of your IRA from creditors who have court judgments against you depends on state law, which varies pretty widely.

For instance, in New York, IRA assets are protected from judgment creditors with few exceptions. A creditor may be able to take from you money you put into the IRA within 90 days before the creditor filed their ultimately successful claim against you. They also may be able to take money a court decides you put in the IRA for the express purpose of keeping it from them.

Types of IRA Bankruptcy Protection

IRA bankruptcy protection covers all types of IRAs:

• Traditional IRAs
• Roth IRAs
• SEP-IRAs
• SIMPLE IRAs
• Rollover IRAs

Traditional IRAs and Roth IRAs 

Historically, the limits on bankruptcy protection for traditional and Roth IRAs have been adjusted every three years. The adjustment in 2022 raised the limit to $1,512,350 from $1,362,800. The next increase will go into effect on April 1, 2025.

SEP-IRAs and SIMPLE IRAs

SEP-IRAs and SIMPLE IRAs are designed for self-employed individuals and small businesses. They receive the same protection as traditional IRAs and Roth IRAs, but there is no limit on the amount that is protected.

Rollover IRAs

BAPCPA identifies rollover IRAs as a traditional IRA or Roth IRA that was originally funded by a rollover transfer from an employer-sponsored retirement plan such as a traditional 401(k) or Roth 401(k). Like SEP and SIMPLE IRAs, protection on these accounts is not capped.

The bankruptcy protection limit placed on traditional and Roth IRAs covers the vast majority of account holders because the account balance maximum is higher than most IRA investors are likely to achieve through a combination of their contributions and the gains made on them during their working years. In addition, BAPCPA permits the protected amount to exceed the limit "if the interests of justice so require."

The Bottom Line

When it comes to IRA bankruptcy protection, certain federal rules apply. If you are unsure whether your IRA assets are protected in your particular case, seek legal counsel.

Frequently Asked Questions (FAQs)