Many people are given wrong information and believe that their Roth and traditional IRA accounts are completely protected. This is not always the case. Each state regulates the amount of legal protection offered for IRA account holders. Most states, including California, fail to provide traditional individual retirement accounts and Roth IRAs with the kind of protection from creditors given to pension plans and 401(k) plans. This is one of the few times that comparing Roth vs. Traditional IRA's has limited weighting. When there is an active lawsuit, all assets can be considered. Since your IRA account earns interest, thus earning you money, it is considered an asset and can be included in lawsuit settlements. An IRA account can also be garnished when filing for bankruptcy. While IRA's are a great way to prepare for the years ahead, these accounts are not completely protected in all circumstances. Actually, California law does shelter money in IRAs and Roth IRAs that is deemed necessary to support the owner and their dependents in retirement, but a judge will determine what exactly this means and can change from judge to judge.
Most lawsuits will not involve a retirement account. This is largely determined by the findings of the case as well as the amount in the account. In short, IRA's can be taken in a lawsuit. There is no way to avoid this should it happen. Even though there is a chance the funds would be garnished, most financial advisors will suggest maintaining the account and contributing as you normally would.
Standard IRA withdrawal rules will apply, even if the withdrawal is due to a lawsuit or a bankruptcy filing. The tax rate is the same as any other early withdrawal and the type of account is not taken into consideration. Whether the IRA is a traditional or Roth, the funds in the account can be subject to lawsuit claims.
Many people ask the question, "what is better, 401k or Roth IRA?" If there is a potential lawsuit, this could be a very important question to consider. 401k accounts are less likely to be considered in lawsuits than IRA's. If you currently have a 401k account with your employer and expect a lawsuit in the near future, it is suggested to keep that account as it is and not roll over the money to an IRA. The only time the money should be transferred in this scenario is when there is a change in employment. Then, the employee must decide to reinvest the money in the new company 401k, or open an IRA account.
Regardless of personal choices, when it comes to legalities, all assets can be garnished during a legal proceeding. This includes personal savings accounts, IRA accounts, 401k accounts and any other assets the individual may have.
IRA accounts were designed to help the working individual save and prepare for retirement. These accounts are the best way to make that financial preparation. They have a high interest rate and allow individuals to make various contributions. If there is a chance that you will be involved in a lawsuit, you may consider ceasing contributions until the suit is settled. This will ensure you do not take the chances of being subject to early withdrawal penalties, but this is usually a minor consideration.
IRA retirement accounts are not completely safe from being garnished, despite federal Supreme Court rulings. In extreme cases, especially those involving large IRA accounts, the courts have the right to take these retirement accounts into consideration. Whether there are legal findings or not, the simple IRA rules always apply as long as the accounts are active. If you are of age and are withdrawing required amounts from traditional IRA accounts, you must continue to do so. The rules do not change if there is a lawsuit or bankruptcy claim in process. All standard rules regarding withdrawals, contributions and penalties must be followed.
IRA accounts are not safe from legal proceedings, but they remain one of the most effective ways to save for retirement. Even though there may be a slight chance of the accounts being garnished, it is suggested to continue your normal habits regarding Roth or traditional IRA accounts. Most advisors will tell you to not change withdrawal schedules or contribution amounts based on the small chance that the account will be considered in a lawsuit.
Rocco Beatrice, CPA, MST (Master of Science in Taxation), MBA (Master of Business Administration), BSBA (Management/Accounting), CWPP (Certified Wealth Preservation Planner), CMMB (Certified Mortgage Broker), CAPP (Certified Asset Protection Planner), Managing Director, Estate Street Partners, LLC. Mr. Beatrice is an asset protection, award-winning trust, estate planning and tax expert.
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