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How to Protect Your Retirement From a Lawsuit

How to Protect Your Retirement From a Lawsuit

Posted on June 7, 2022
Writer: James Miller

Most companies offer retirement accounts, such as a 401(k), as part of the benefits package. Similarly, many individuals may also open an Individual Retirement Account (IRA) if they are not offered a 401(k) through their employer.

Unfortunately, unexpected events may occur that may endanger your retirement accounts. Therefore, it is important to know how to protect your retirement savings if you are caught up in a lawsuit. Here are some tips and answers that may help you:

Using a 401(k) For Retirement

Employer-sponsored 401(k) accounts are popular because they allow the company to match your contributions. Typically, your employer will make regular contributions to the account that are a portion of your salary.

Additionally, most company-sponsored 401(k) plans are usually protected against creditors, but that is not always the case. To be sure, we recommend that you ask your company’s plan administrator if your 401(k) offers these protections.

How Can My 401(k) Or IRA Be Taken in a Lawsuit?

If your company’s 401(k) plan is not protected against creditors, then your account may be seized in a lawsuit. Fortunately, most federal laws protect 401(k) accounts from this type of action.

For example, the Employee Retirement Income Security Act (ERISA) is a federal law that protects a person’s 401(k) account. Your 401(k) funds legally belong to the plan administrator or your employer until you withdraw them as income during retirement. As a result, the plan administrator cannot legally release the funds to anyone except your beneficiaries.

However, once you take out funds to use during your retirement, ERISA no longer protects the funds you have taken out, and creditors may seize them. Additionally, although ERISA protects 401(k) accounts from lawsuits and bankruptcy, it does not protect it against the federal government.

Additionally, IRAs are not covered by ERISA. Therefore, creditors, such as banks, may be able to go after your IRA in a lawsuit.

When Is My IRA or 401(k) in Danger?

Your 401(k) may be in danger if there is a stock market crash. When individuals allocate a percentage of their pre-tax salary into a 401(k), the money goes into stocks, bonds, and mutual funds. Therefore, if there is a stock market crash, your retirement account may depreciate.

Additionally, your 401(k) may be in danger of seizure if you owe money to the federal government in income taxes or penalties. Note that state or local authorities cannot seize your 401(k), and only the federal government can enforce a judgment. Even if a state or local authority wins a judgment against you in court, they cannot obligate you to take out money from your 401(k). These authorities may only go after your wages and money in the bank.

Also, when you have to pay for child support or alimony, the court may decide to withdraw money from your 401(k) to pay for these funds. Funds may also be seized from your 401(k) if you get divorced and the court orders your spouse to get a share of your 401(k).

However, a great thing about a 401(k) is the protection surrounding it. Even if you fall into debt from several missed credit card payments, the ERISA law still provides a safety net for you and your 401(k) investment.

Your Traditional IRA may be in danger if you are in a higher tax bracket when you retire. This means you will get taxed at a higher tax rate when you withdraw your retirement funds. Your Roth IRA may be in danger if you are in a lower tax bracket when you retire. This means that you were taxed on the funds you put in your account at a higher tax rate so it would have been more cost-efficient to put your money in a Traditional IRA.

IRA Protection by State

Just in case, it is important to check if your state provides IRA protection. If your state offers IRA protection, that means that creditors cannot come after your IRA account. Check the chart to see if your state provides partial or full IRA asset protection.

Among the most popular types of IRAs which are Traditional and Roth, there are quite a few others to select from.

Traditional IRA

  • Most popular of the individual retirement savings accounts due to the tax advantages
  • Receive up to $6,000 in an upfront tax break
  • If you are 50 years of age or older, on top for the $6,000 in the upfront tax break, you may also receive $1,000
  • Your contributions may count as a deductible, therefore reducing your taxable income
  • Withdrawals in your retirement funds will be taxed at the tax rate you withdraw the funds
  • Typically chosen for those in a higher tax bracket or those who do not have access to a work sponsored retirement fund

Roth IRA

  • There is no upfront tax break, however when the individual withdraws the money during retirement, it is completely tax-free
  • Similarly with Traditional, the max annual contribution is $6,000 and $7,000 for those 50 years of age or more.
  • Withdrawals are considered more lenient than in Traditional IRA because it allows tax-free withdrawals at any time however if it is before the retirement age, there may be taxes and penalties associated with the withdrawal
  • Typically chosen for those who plan on having a higher tax bracket in retirement and for those who may need to withdraw some of their retirement funds before retirement age

SEP (Simplified Employee Pension) IRA

  • SEP is a type of Traditional IRA; however, it is a work sponsored IRA
  • Earnings within the SEP IRA is tax-free and withdrawals during retirement are taxed
  • You are able to invest more in this account than the maximum $6,000 – either 25% of the employee’s compensation or $61,000
  • Employers are required to contribute equally to their employee accounts
  • Employees must work for the employer for at least 3 years and earn at least $600 during the last year to be eligible for SEP
  • Typically chosen by small-business owners who do not want to pay for a conventional retirement plan

Spousal IRA

  • For couples that have a joint tax return and have taxable compensation
  • A nonworking spouse may contribute up to $6,000 or $7,000 if 50+ and the working spouse can contribute the same amount of their own IRA
  • Maximum you both can contribute is less than your joint taxable income or double the annual IRA contribution limit so $12,000 for those under 50+
  • Typically chosen by low-income couples or nonworking individual who marry a working individual

IRA Protection From Lawsuit by State:

StateProtection for Traditional IRAProtection for Roth IRAStatute
ALYesYesAla. Code §19-3B-508
AKYesYesAlaska Stat. §09.38.017
AZYesYesAriz. Rev. Stat. §33-1126(B)
ARYesYesArk. Code §16-66-220
CAPartialNoCal. Code of Civ. Proc. §704.115
COYesYesColo. Rev. Stat. §13-54-102
CTYesYesConn. Gen. Stat. §52-321 a
DEYesYesDel. Code Ann. tit. 10, §4915
FLYesYesFla. Stat. §222.21
GAYesNoGa. Code §44-13-100
HIYesYesHaw. Rev. Stat. §651-124
IDYesYesIdaho Code §55-1011
ILYesYes735 III. Comp. Stat. 5/12-1006
INYesYesInd. Code §34-55-10-2(6)
IAYesYesIowa Code §627.6(8)
KSYesYesKan. Stat. §60-2308
KYYesYesKy. Rev. Stat. §427.150(2)(f)
LAYesYesLa. Rev. Stat. §§20-33(1) and 13-388KD)
MEPartialNoMe. Rev. Stat. tit. 14, §4422(13)(F)
MDYesYesMd. Code Cts. & Jud. Proc. §11-504(h)
MAYesYesMass. Gen. Laws ch. 235, §34A
MIYesYesMich. Comp. Laws §600.6023(j)
MNYesYesMinn. Stat. §550.37(24)
MSYesNoMiss. Code §85-3-1
MOYesYesMo. Rev. Stat. §513.430.1
MTYesNoMont. Code §31-2-106(3)
NEPartialNoNeb. Rev. Stat. §25-1563.01
NVYesYesNev. Rev. Stat. §21.090(1)(r)
NHYesYesN.H. Rev. Stat. 52 §511:2
NMYesYesN.M. Stat. §§42-10-1,-2
NJYesYesN.J. Stat. 25:2-1 (b)
NYYesYesN.Y.C.P.L.R. 5205(c)
NCYesYesN.C. Gen. Stat. § 1C-1601 (a)(9)
NDYesYesN.D. Cent. Code §28-22-03.1(7)
OHYesYesOhio Rev. Code §2329.66(A)(10)
OKYesYesOkla. Stat. tit. 31, §1(A)(20)
ORYesYesOr. Rev. Stat. §18.358
PAYesYes42 Pa. Cons. Stat. §8124(b)(1 )(ix)
RIYesYesR.l. Gen. Laws §9-26-4(11)
SCYesYesS.C. Code §15-41-30
SDYesYesS.D. Codified Laws 43-45-16;43-45-17
TNYesYesTenn. Code §26-2-105
TXYesYesTex. Prop. Code §42.0021
UTYesYesUtah Code §78-23-5(1 )(a)(xiv)
VTYesYesVt. Stat. tit. 12, §2740(16)
VAYesYesVa. Code §34-34
WAYesYesWash. Rev. Code §6.15.020
WVYesNoW.Va. Code §38-10-4
WIYesYesWis. Stat. §815.18(3)(j)
WYPartialPartialWyo. Stat. §1-20-110

California offers partial protection if the individuals have other ways of supporting themselves during retirement. In this case, the creditor may seize the account if there is a court ruling.

In Maine, traditional IRAs are partially protected if the account totals $15,000. Also, the account may be protected if a judge decides that the debtor needs the money.

In Nebraska, there may be an exemption depending on the judge’s decision. If the judge deems that the debtor needs the money to support themselves or any dependents, their IRA is protected.

In Wyoming, the debtor is exempt if they have the means to pay off the debt.

Additional Benefits of Retirement Accounts

Aside from protecting your assets, investing in retirement accounts can also afford you tax benefits. Tax-deferred accounts, such as traditional IRAs and 401(k) plans, allow the investor to realize immediate tax deductions for up to the entire amount of the contribution. For example, if your taxable income is $60,000, and you contribute $5,000 to your 401(k), then you would only pay taxes on $55,000. Tax-deferred accounts are great for people who do not want to pay as much tax in the current year.

There are also tax-exempt accounts, such as a Roth IRA and a Roth 401(k). These accounts provide future tax savings as they exempt the investor from paying taxes when they withdraw funds for retirement.

Additionally, Traditional and Roth IRAs are simple to open. Once you figure out where to open your IRA, you will have to choose the type and then open your account. Then, you can make contributions to your IRA and invest your money. You also have sole ownership of your IRA and can assign beneficiaries, if you wish to.

Other Investments to Increase Retirement Funds

Diversifying your investments into physical assets is an excellent option because your retirement funds may not be seized as easily. For instance, you can roll over your traditional retirement account into a gold IRA account that includes IRS-approved physical assets, such as gold coins and bars.

Another long-term investment that could protect your retirement funds is directly purchasing gold coins and bars. With a gold IRA, you can obtain ERISA protection. Also, it is typically more difficult to garnish assets when they are held in physical gold.

Other Investments to Increase and Secure Retirement Funds

For extra protection, some may invest in separate insurance policies, such as umbrella policies. The great thing about umbrella policies is that the insurance provider is obligated to provide you with legal counsel along with your coverage. If you are required to pay out a claim in a lawsuit, the umbrella policy will cover you after your standard liability insurance ends.

However, some umbrella insurance policies do not cover lawsuits regarding intentional acts, such as business activities. This includes any liability that occurred in a business or professional setting. As a result, you would need separate insurance, typically business liability insurance, to get this covered.

The Bottom Line

To recap, most 401(k) accounts are protected from lawsuits and bankruptcies under ERISA law. Although IRAs do not fall under ERISA, most states have laws that protect against IRA account seizure. However, it is always a good idea to invest in other accounts, such as gold IRAs, to protect you from potential lawsuits or federal judgments that may endanger your money.

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