Normally, retirement plans are
generally considered safe from creditors. A recent ruling by the Bankruptcy
Panel for the 8th U.S. Circuit Court of Appeals has called that safety
into question. An individual was awarded ½ of his ex-wife’s 401(k) plan and her
entire individual retirement account in their divorce settlement. He later
filed for Chapter 7 bankruptcy and claimed those assets were exempt from
creditors because they were in retirement plans. The Bankruptcy Panel disagreed
on the basis that the retirement plans were not originally his; thus, they were
subject to creditor claims.
Defined contribution 401(k) plans
are sheltered from creditors in bankruptcy filings for individuals who own the
plan. IRAs are also usually exempt from bankruptcy as well (subject to a cap
under federal law that is approximately $1.2 million). However, once the assets
are separated from the original owner, you should expect that the asset protection
will go away. In the Supreme Court ruling of Clark v. Rameker, the Court held
that inherited IRAs are not considered retirement funds for bankruptcy
protection.
Although the 8th Circuit
ruling applies only in that district, other courts may follow suit. For
protection, IRA assets received in a divorce settlement should not be
intermingled with the individual’s own IRA. Co-mingling funds could possibly
jeopardize the creditor protection of the entire IRA.
Please note that this discussion
does not constitute legal or tax advice; it is informational only. Your
individual circumstances should be discussed with your legal and/or tax
counsel. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX. We offer financial planning and investment management services to our clients.
