There is a widely held belief that creditors and lawsuits can’t touch retirement accounts—but that is not always true.

Reality: Whether retirement accounts are safe depends on a range of factors including the type of account, type of creditor, state of residence, whether the account owner seeks bankruptcy protection and whether he/she has trusts that provide additional security.

What is typically protected: Assets in 401(k)s and other qualified ERISA (Employee Retirement Income Security Act) employer plans are usually completely protected from most creditors. The same applies to IRAs that were created via rollovers from ERISA accounts and that have never been commingled with other funds. But there are exceptions: The IRS can reach these assets if there’s a tax lien…and a spouse could get a share of them in a divorce—a spouse is considered a potential co-owner of the assets, not a creditor.

What might not be protected: Assets in IRAs that were not created via rollovers from ERISA accounts—it often depends on state law. Most states provide unlimited protection for IRAs that were funded by the IRA owner’s own contributions—but again, this won’t protect the assets against IRS tax liens or divorce settlements. Certain states place limits on this protection, and a few—most notably Maine and Nebraska—provide very little protection.

The Bankruptcy Abuse and Consumer Protection Act of 2005 ensures that most retirement account assets are safe from creditors even if bankruptcy is declared. Its protection is unlimited for ERISA plans but currently is limited to $1,512,350 for many types of IRAs—that figure increases to keep pace with inflation. This limit does not apply to IRAs that are funded solely through rollovers from ERISA plans (that is, they are not commingled with regular IRA contributions).

But: Inherited IRAs are not protected by Federal bankruptcy rules. Some states, including Alaska, Arizona, Florida, Missouri, North Carolina, Ohio and Texas, have laws that protect inherited IRAs in bankruptcy and/or other situations, but many other states provide limited or no protection.

More bad news: If a creditor manages to reach retirement assets and the assets taken by the creditor are from a tax-deferred account, such as an IRA, the account owner likely will have to pay income taxes on the money the creditor receives. Even worse: If the account holder hasn’t reached age 59½, he might also face early-withdrawal penalties.

To protect retirement assets: Obtain professional liability and/or umbrella insurance coverage for additional financial protection against lawsuits. If you roll over a 401(k) into an IRA, don’t commingle that rollover IRA with other assets.

If you’re worried that your heir’s creditors or spouse might target your retirement savings after your heir inherits them, ask your estate-planning attorney whether it makes sense to set up an “accumulation trust” to serve as beneficiary of your IRA, with the heir as the trust beneficiary. The trustee could keep the assets safe inside the trust if creditors or divorce pose a risk. Don’t rely on state laws to protect your heir’s inherited IRA from creditors—your heir might move to a state that provides little protection.

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