Are you at risk of being sued? If you’re breathing, the answer is yes. Of course some people are at greater risk of being sued than others: people with unpaid debts, people who own property, people who drive, people who work in high-liability professions and people who have assets worth going after. Do you fall into one of these categories? If so, here’s what you need to know about whether your retirement funds are protected against a lawsuit.
What Happens to Your 401(k) or Pension
A federal law known as the Employee Retirement Income Security Act of 1974 (ERISA) protects private employer retirement plans such as 401(k)s and pensions against lawsuits. The law’s “anti-alienation” provision prevents your plan’s benefits from being assigned to creditors. Section 206(d)(1) reads, “Each pension plan shall provide that benefits provided under the plan may not be assigned or alienated.”
ERISA does not protect retirement plan assets against qualified domestic relations orders. These are judgments, decrees or orders, including property settlement agreements, related to child support, alimony or marital property rights. So if you get divorced, your spouse could claim part of your pension, 401(k) or other ERISA plan.
What Happens to Your IRA
Individual retirement accounts (IRAs) are not protected by ERISA. Instead, state law determines whether your IRA assets are at risk if you are sued.
Most states have looser protections for traditional and Roth IRAs than they do for 401(k)s and pension benefits. Your IRA might be protected only to the extent that it supports the bare essentials for you and your dependents in retirement, as determined by a judge’s discretion. Further, if you are well below retirement age and still able to work, a judge might deem it acceptable to turn your IRA assets over to judgment creditors.
Arizona, Texas and Washington are among states that do protect IRA assets, while New Mexico and New Hampshire do not protect them at all. Tax Adviser magazine has published a chart of state IRA protections where you can see what laws apply to your IRA assets.
A simplified employee pension (SEP) is a type of IRA that an employer contributes to on an employee’s behalf. It’s “simplified” because it doesn’t have the reporting and disclosure requirements that most other retirement plans do. A SEP isn’t protected by ERISA either. The same is true of a savings incentive match plan for employees, also known as a SIMPLE IRA.
An ERISA-based exception to the rules that generally apply to IRAs does protect assets rolled over into an IRA from a plan you used to maintain with an employer, such as a 401(k).
Other Plans Vulnerable to Lawsuits
Keogh plans, 403(b) plans, employer-only plans, government plans and church plans are not protected from judgment creditors by ERISA. That means your state’s laws determine whether these assets are protected.
Retirement-Fund Withdrawals: Still Protected?
Once you have taken a distribution from a retirement plan, that distribution is no longer part of your plan and is no longer subject to its protections against lawsuits. However, federal benefits such as Social Security payments, Veterans Administration benefits and Railroad Retirement Act benefits are protected even after they’ve been paid out.
Umbrella insurance, professional liability insurance and asset protection trusts are tools you can use to protect your retirement assets from being decimated by a lawsuit or garnished when you start taking distributions. Many lawsuits result from accidents, so even if you’re extremely careful, you can’t assume you will never be sued. The best way to protect your retirement assets against a lawsuit is by combining reasonable behavioral precautions with the proper insurance.