Bankruptcy Protection for Retirement Assets

In these uncertain financial times we get more and more questions about whether 401(k)s and other retirement vehicles are protected in case of bankruptcy.

The short answer is yes.

The Employee Retirement Income Security Act of 1974 (ERISA) and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) provide federal protection for retirement assets upon bankruptcy.

However, there can be significant differences in protection based on the type of retirement account.

So, here is a longer answer:

ERISA provides the strongest protection for retirement assets. These rules state that your retirement assets can not be assigned or alienated, except under very limited circumstances (e.g. IRS tax levy, qualified domestic relations order, participant loan default). This means that ERISA protected assets are exempt from the employer’s and employee’s bankruptcy estate.

Historical Note: While ERISA has been around for a while, it wasn’t until 1992 that the Supreme Court unanimously ruled that the anti-alienation rules of ERISA apply to bankruptcy cases. This ruling settled a long standing difference among the federal appellate courts.

401(k), profit sharing, defined benefit and most other employer sponsored retirement plans are covered under ERISA. There are a few notable exceptions. ERISA does not cover:

• Solo 401(k) plans (i.e. plans covering only self employed individuals)
• Certain deferral only 403(b) plans
• SIMPLE and SEP IRAs
• Traditional and Roth IRAs
• Certain governmental plans (e.g. 457)

Fortunately, since October 17, 2005, we have BAPCPA to protect these other types of plans. This law provides bankruptcy protection for “tax-exempt” assets held in these accounts.

Protections under BAPCPA are not as strong as those under ERISA. Specifically BAPCPA doesn’t protect IRA assets in excess of $1 million. (This cap doesn’t apply to SIMPLE, SEP and rollover IRAs. Meaning if you rollover your 401(k) to an IRA the entire rollover amount is protected even if it exceeds $1 million.)

In addition BAPCPA doesn’t protect retirement assets in non-bankruptcy judgments, such as civil lawsuits. ERISA’s stronger anti-alienation rules protect retirement assets in almost all instances. (An interesting exception is the use of a fiduciary’s ERISA protected account to repair a fiduciary breach.)

Hopefully these answers help employers and participants sleep easier knowing their retirement assets are protected.