One of the less well-known advantages to IRAs, but an important one nonetheless, is that they provide a significant amount of protection from creditors during bankruptcy. This protection comes under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) that went into effect in 2005. The BAPCPA provides protection for up to $1 million in assets held in traditional or Roth IRAs, and is subject to regular inflation adjustment. For purposes of the BAPCPA, a rollover IRA is a traditional or Roth IRA account that was originally funded through a transfer from a qualified retirement plan.
A July article in Forbes discussed a recent case that demonstrated in practice the intersection between bankruptcy law and the exempt status of IRAs. In this case, debtors had filed for Chapter 7 bankruptcy and claimed an exemption for money in an IRA. Usually a fairly routine matter in bankruptcy cases, the issue here was how the lack of a rollover affected the status of the IRA exemption. The debtors had withdrawn money from the IRA and used it to pay expenses, and these funds were not rolled over into another IRA.
The bankruptcy court held that these funds had lost their exempt status because they were not rolled over to another IRA within 60 days. The debtors appealed the decision to the district court and then to the Fifth Circuit Court of Appeals; both courts affirmed the ruling. A relevant quote from the Fifth Circuit decision, quoted in the Forbes article:
“When the [debtors] failed to deposit the funds into another retirement account within sixty days of withdrawal, the conditional exemption expired, and the [debtors] lost their right to withhold the funds from the estate.”
As the article concludes, while IRAs enjoy substantial creditor protection, it’s important to note that this protection is sensitive to the facts of the individual case and the governing law.