It is important to understand the creditor protection rules as they apply to IRAs especially when the economy is turning sour. Often times, IRA account holders do not realize until it is too late that anxious non-bankruptcy creditors (general creditors) can come after IRAs. To read our prior post on the IRA bankruptcy rules VISIT HERE. This blog post covers the IRA rules that apply when dealing with general creditors (non-bankruptcy).
IRA Protection from General Creditors Falls at the Sate Level NOT the Federal Level
State law not federal law determines if an IRA is exempt from seizure by creditors, and the level of protection varies by state, with some states offering no protection to partial protection and others providing full protection.
Example:Fred is 52 and has accumulated a large IRA balance as a result of being a consistent saver all his life. Fred gets sued by his neighbor and looses. His neighbor can come after Fred’s IRA funds and may be successful if Fred lives in a state that does not shield IRAs from general creditors.
Tip: If you live in a state where general creditor protection is not afforded to IRAs, and and you also work for a employer that offers an 401k plan, consider rolling over some or all of your IRA funds to that employer’s 401k plan if you are expecting a lawsuit as employer 401k plans are fully protected from general creditors.
Example: Jackie is a successful doctor whose profession exposes her to malpractice lawsuits. She also lives in a state that does not protect IRAs from general creditors. Jackie also participates in her employer’s 401k plan and discovers that 401k plans are fully protected from general creditors. As a result, Jackie rolls over / transfers her IRA to her employer’s 401k plan, resulting in her IRA funds now being fully protected from general creditors.
Using an LLC to Shield Self-Directed IRA Assets
To protect against claims brought against IRA investments, the IRA participant will open an IRA LLC. This is especially the case for self-directed IRAs (e.g., IRAs that hold real estate). When alternative investments like rental properties are made under an IRA owned Limited Liability Company (LLC), the IRA investments are indirectly protected under the veil of the LLC. The IRA participant’s personal assets are also protected as an added bonus, meaning creditors that attempt to go after the IRA LLC owned asset (e.g, an investment property) cannot also try to collect on the IRA participant’s personal assets.
Example: Gina invested her self-directed IRA LLC in a rental home, and she rents the IRA owned LLC property to an unrelated party. The tenant then slips on the rental home’s icy driveway and throws his back out. He then sues Gina and her IRA LLC for the payment of medical bills but is not successful because the IRA is protected under the LLC. Likewise, Gina’s personal assets are also protected.