When you roll over assets from an ERISA-qualified employer-sponsored retirement plan, such as a 401(k), into an Individual Retirement Account (IRA), the protection from creditors in bankruptcy for the rolled-over funds can be a bit complex and depends on several factors, including federal law, the specifics of the rollover, and potentially state law.
Here's a general overview of how the protection works:
1. **Federal Protection for Rolled-Over Funds**: Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), rolled-over funds from an ERISA-qualified plan into an IRA generally retain unlimited bankruptcy protection. This means that the funds rolled over from 401(k)s and similar plans into an IRA are supposed to be fully protected from creditors in bankruptcy, without being subject to the IRA protection cap that applies to regular IRA contributions.
2. **Clarification by the Supreme Court**: The Supreme Court has recognized that funds rolled over from a qualified plan into an IRA retain their protected status. The intention is to encourage and protect retirement savings, recognizing the importance of these assets for an individual's retirement security.
3. **Treatment of Contributions and Earnings**: It's important to distinguish between the rolled-over funds and any additional contributions made directly to the IRA or earnings on those contributions. The additional contributions and earnings are subject to the regular IRA bankruptcy protection cap, which is adjusted periodically for inflation (as of 2023, approximately $1,512,350 for all IRAs combined, but this amount is subject to change).
4. **Documentation and Record-Keeping**: To ensure that the rolled-over funds receive the appropriate level of protection, it's critical to maintain good records. This includes documentation of the rollover transaction, showing that the funds were transferred from an ERISA-qualified plan to the IRA. This documentation can be crucial in a bankruptcy proceeding to prove that the funds are eligible for the unlimited protection associated with their origin in an ERISA-qualified plan.
5. **State Law Considerations**: While federal law provides a broad layer of protection, state laws may also play a role in how retirement assets are treated in bankruptcy. Some states offer additional protections for IRAs beyond federal law, which could potentially affect how rolled-over funds are treated. However, the federal bankruptcy exemptions typically offer robust protection for rolled-over retirement funds.
Given the complexity of these issues and the potential for significant financial impact, individuals considering a rollover or facing bankruptcy should consult with a legal or financial professional. This ensures that they fully understand the protections applicable to their retirement assets and can make informed decisions accordingly.
