In general, retirement accounts receive protections in bankruptcy, so that you will have money available to live on after you leave the workforce.
To discourage people from taking money out of these accounts before retirement, they are subject to hefty early-withdrawal penalties and taxes. If you do pay the fees and taxes and take money out to pay a portion of your bills, it loses the exempt status.
Not all retirement accounts are treated the same. If you inherit an IRA from a loved one, for example, the account is not protected in a Chapter 7 or Chapter 13 bankruptcy following a recent U.S. Supreme Court decision.
In this post, we will discuss how the three main types of retirement accounts are treated.
Employer-sponsored 401(k) accounts and pension plans receive the broadest protection. These are often the main vehicle that individuals use to save and generous employers may even have a matching program. A rollover from a company plan to a traditional IRA does not usually change the protected status.
Traditional IRA and Roth IRAs are accounts set up by an individual to save for retirement. Each has tax advantages and again early withdrawal penalties. Tradition and Roth IRAs receive protection up to about one million dollars.
The inherited IRA is different according to the nation’s high court. Because the person who inherits it cannot add to the account and can take out the money at any time without a penalty, these accounts do not receive the same protections in bankruptcy. The heir actually has five years from the original owner’s death to take out the whole balance or must withdraw a certain amount each year.
It is not often that the highest court hears a bankruptcy case. This one resolved a gray area that has existed since the 2005 overhaul of the bankruptcy code.
Source: Forbes, “Supreme Court Finds Inherited IRAs Not Protected In Bankruptcy,” Deborah Jacobs, June 12, 2014.