Social Security benefits, company pensions, and 401(k) plans are all shielded by law and are, therefore, not lost to creditors in bankruptcy. Whether that same protection extends to an individual retirement account (IRA) is not clear. The bankruptcy law, which was drafted in the 1970s, before IRAs became such an important vehicle for retirement savings, is ambiguous. This has led to contradictory rulings in federal courts around the country.
One federal appeals court has ruled that IRAs are not protected by a law that preserved the debtor's right to receive retirement payments on account of illness, disability, death, age or length of service. The court found that IRAs did not fit in the category of qualified retirement plans because anyone willing to pay a 10 percent penalty can withdraw money from an IRA for any reason.
Another federal appeals court ruled that IRA accounts are exempt from bankruptcy only when the account holder has reached 59 1/2, the age at which money may be withdrawn without penalty. Other courts have imposed no restrictions, reasoning that IRAs are similar enough to other retirement plans, all of which allow early withdrawals under at least some circumstances to fit within the definition and qualify for the exemption.
In light of the ambiguity, many states, including New York and California, have enacted legislation to shelter IRAs from bankruptcy. Federal bankruptcy law permits people to avail themselves of any greater protections offered by state law.
Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.