Protecting an IRA from creditors

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Q. In order to protect some significant monetary assets, mainly in IRA accounts and my home, I am considering an umbrella liability insurance policy of at least $1 or $2 million. This would add an extra $360 to $475 annually to my home and auto insurance costs. Are IRA assets subject to litigation and seizure, or are they protected from such lawsuits?
— Protecting what’s mine

A. IRAs may be protected from the claims of creditors, but it depends on your state of domicile.

If you live in New Jersey, the coast is clear.

The state will protect your IRA completely, said Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield.

He said most other states do protect IRAs, but some provide only a partial exemption either only allowing a set dollar amount to be exempt or only allowing an amount of your IRA that is “reasonably necessary for the support” of you and your dependents.

“There is no set definition of what `reasonably necessary’ means, and courts in those states will typically consider it on a case-by-case basis,” Papetti said.

If you reside in a state that only exempts part of your IRA, this may be an issue if you have a large IRA account, are relatively young and can make more contributions into your plan or you have other sources of income to support yourself and your dependents.

As for your concern of a lawsuit, if you are sued and lose, creditors can obtain and seek to satisfy a judgment by attaching and seizing your assets and/or garnishing your wages, Papetti said.

But you’re safe if you’re a New Jersey resident.

“New Jersey applies this rule not only to traditional IRAs but also to Roth IRAs and other types of retirement accounts, such as SEP-IRAs,” he said. “Qualified retirement plans such as pensions, 401(k) plans and profit sharing plans are also 100 percent protected from creditors.”

There are exceptions when your IRA or qualified retirement plan may be at risk from a creditor. The IRS may go after your accounts for federal income tax debts and the federal government may seize the assets for criminal fines and penalties, Papetti said.

He said it could also be an issue in the case of civil or criminal judgments where you did something wrong against the qualified retirement plan.

And, your ex-spouse, under a Qualified Domestic Relations Order (QDRO), could go after the assets to the extent of your spouse’s interest in those benefits as a marital asset or as part of a child support attachment.

“Also note that distributions from your IRA and/or qualified retirement plan may no longer be protected once they leave the plan and are distributed to you,” Papetti said. “For example, if you deposit the distributions you receive from a retirement plan into a regular checking account, then a judgment creditor may be able to seize those funds in the checking account.”

Now, umbrella insurance. These policies are for personal excess liability and protect the insured above and beyond the dollar limits specified in your homeowners, auto or other personal insurance policies, Papetti said.

This type of insurance is designed for added protection from lawsuits and other claims that may be brought against you. It’s a very cost effective way to protect your assets and financial future, Papetti said.

“Umbrella insurance is a secondary type of insurance that requires a primary policy such as homeowners or auto policy that has minimum required liability limits to pay out on a claim before the umbrella policy coverage becomes effective,” he said. “If you have accumulated assets and/or are still saving for your future, I am a proponent of having an umbrella policy.”

The amount of your assets and/or the potential loss of future income should help determine the amount of umbrella protection you need, he said.

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NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.