Pensions, IRA’s and 401K’s are protected against creditors, but watch out for disqualification

I just returned from the annual conference of the National Association of Bankruptcy Trustees. Trustees are always on the lookout for novel ways to snag assets to collect or sell to pay creditors. I learned that one way this can happen is if a debtor in bankruptcy has done something that renders an IRA or Profit Sharing Plan disqualified. Most IRA’s or Profit Sharing plans are invested in publicly traded mutual funds, stocks, bonds or other investments. But some people think the “investments” can include family loans or money used for other purposes.  If these non-traditional investments fall outside the rules, the plan could be disqualified.

Normally, IRA’s, Profit Sharing Plans, Pensions, and other “ERISA Qualified” retirement plans are completely protected from the claims of creditors. However, if and to these are rendered disqualified because of improper investments or contributions, that protection could disappear in whole or in part. Bad News.

Here is how that could happen. (These are examples and are not necessarily a complete list. The laws and regulations governing pensions and IRA’s are complex). Certain activities are prohibited and could disqualify an IRA. These include borrowing against the IRA or pledging it as collateral for a loan, commingling IRA and non-IRA assets. If the IRA was funded by a rollover from a pension that is disqualifed that rollover could disqualify the IRA as well.

Of related concern is excess contributions to an IRA beyond the amount allowed.  IRA annual contributions are allowed  up to a certain amount each tax year. If you make excess contributions, that might or might now not disqualify the IRA. However, you may expect a  trustee or creditor to object to the excess contributions and  claim that the extra payments were made to improperly avoid paying creditors and that such excess contributions are a fraudulent transfer which the trustee or creditor can get back. Or as happened in one case, the excess payments were not protected as exempt and had to be turned over.

So this is an area to be careful about.

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