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:
State
Protection for Traditional IRA
Protection for Roth IRA
Statute
AL
Yes
Yes
Ala. Code §19-3B-508
AK
Yes
Yes
Alaska Stat. §09.38.017
AZ
Yes
Yes
Ariz. Rev. Stat. §33-1126(B)
AR
Yes
Yes
Ark. Code §16-66-220
CA
Partial
No
Cal. Code of Civ. Proc. §704.115
CO
Yes
Yes
Colo. Rev. Stat. §13-54-102
CT
Yes
Yes
Conn. Gen. Stat. §52-321 a
DE
Yes
Yes
Del. Code Ann. tit. 10, §4915
FL
Yes
Yes
Fla. Stat. §222.21
GA
Yes
No
Ga. Code §44-13-100
HI
Yes
Yes
Haw. Rev. Stat. §651-124
ID
Yes
Yes
Idaho Code §55-1011
IL
Yes
Yes
735 III. Comp. Stat. 5/12-1006
IN
Yes
Yes
Ind. Code §34-55-10-2(6)
IA
Yes
Yes
Iowa Code §627.6(8)
KS
Yes
Yes
Kan. Stat. §60-2308
KY
Yes
Yes
Ky. Rev. Stat. §427.150(2)(f)
LA
Yes
Yes
La. Rev. Stat. §§20-33(1) and 13-388KD)
ME
Partial
No
Me. Rev. Stat. tit. 14, §4422(13)(F)
MD
Yes
Yes
Md. Code Cts. & Jud. Proc. §11-504(h)
MA
Yes
Yes
Mass. Gen. Laws ch. 235, §34A
MI
Yes
Yes
Mich. Comp. Laws §600.6023(j)
MN
Yes
Yes
Minn. Stat. §550.37(24)
MS
Yes
No
Miss. Code §85-3-1
MO
Yes
Yes
Mo. Rev. Stat. §513.430.1
MT
Yes
No
Mont. Code §31-2-106(3)
NE
Partial
No
Neb. Rev. Stat. §25-1563.01
NV
Yes
Yes
Nev. Rev. Stat. §21.090(1)(r)
NH
Yes
Yes
N.H. Rev. Stat. 52 §511:2
NM
Yes
Yes
N.M. Stat. §§42-10-1,-2
NJ
Yes
Yes
N.J. Stat. 25:2-1 (b)
NY
Yes
Yes
N.Y.C.P.L.R. 5205(c)
NC
Yes
Yes
N.C. Gen. Stat. § 1C-1601 (a)(9)
ND
Yes
Yes
N.D. Cent. Code §28-22-03.1(7)
OH
Yes
Yes
Ohio Rev. Code §2329.66(A)(10)
OK
Yes
Yes
Okla. Stat. tit. 31, §1(A)(20)
OR
Yes
Yes
Or. Rev. Stat. §18.358
PA
Yes
Yes
42 Pa. Cons. Stat. §8124(b)(1 )(ix)
RI
Yes
Yes
R.l. Gen. Laws §9-26-4(11)
SC
Yes
Yes
S.C. Code §15-41-30
SD
Yes
Yes
S.D. Codified Laws 43-45-16;43-45-17
TN
Yes
Yes
Tenn. Code §26-2-105
TX
Yes
Yes
Tex. Prop. Code §42.0021
UT
Yes
Yes
Utah Code §78-23-5(1 )(a)(xiv)
VT
Yes
Yes
Vt. Stat. tit. 12, §2740(16)
VA
Yes
Yes
Va. Code §34-34
WA
Yes
Yes
Wash. Rev. Code §6.15.020
WV
Yes
No
W.Va. Code §38-10-4
WI
Yes
Yes
Wis. Stat. §815.18(3)(j)
WY
Partial
Partial
Wyo. 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.
James Miller is a Senior Content Writer at McGruff.com. He has a background in investing and has spent most of his career in the financial industry. He can trace his family tree back to the California Gold Rush when his ancestors risked it all to make it big in the west. He feels like he's following in their footsteps as he strives to make sense of today's gold market.
