According to the Association of Trial Lawyers, the annual cost of lawsuits to the U.S. economy is $233 billion. The average amount awarded in a punitive damage lawsuit is $50,000. Insurance is one way to protect yourself from a negative outcome in a lawsuit. Asset protection is another. The Employee Retirement Income Security Act protects retirement assets in an employer-sponsored account. Some asset protection is afforded owners of IRAs, but not as much as is provided for plans covered by the act.
ERISA and Rollover IRAs
The Employee Retirement Income Security Act, known as ERISA, is a federal law that protects retirement assets from pursuit and attachment by creditors, including judgments, liens or other actions a judge may take in a lawsuit. The only exception is that the act does not provide protection against suits by former spouses or the IRS. IRAs rolled over from ERISA-protected accounts do typically enjoy similar protection, but not always.
Company-originated and Personal IRAs
Varying state laws provide protection levels that range from minimal IRA asset protection from lawsuit judgments and creditors to complete shielding from all such claims. States also may differentiate on the level of protection allowed based on whether the IRA is employer-sponsored or opened by the individual. Employer-originated IRAs include Simplified Employee Plan IRAs and Savings Incentive Match Plan for Employees IRAs. Traditional IRAs and Roth IRAs are examples of personal IRAs. Where states differentiate, SEPs and SIMPLEs typically enjoy stronger protection than personal IRAs.
Examples of Protection Levels
In some states your IRA could be garnished. When you lose a lawsuit and do not appear to have available assets or insurance to pay the assessment, some states will factor in your IRAs when calculating your ability to pay. The judge then considers what is owed and what is available from which sources in making the final determination. In some states the courts consider a number of factors to determine whether any or all of the IRA should be exempted. Other states automatically shield IRA assets up to a specified amount. Still others provide unlimited protection to all IRA accounts.
IRA Protection in Bankruptcy
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 clarified and strengthened the laws governing IRAs and the level of protection from all creditors in bankruptcy. If a lawsuit against you results in a huge judgment, you have a sizable IRA and you reside in a state that provides IRA assets with minimal creditor protection, bankruptcy may be a viable option. If neither you nor your attorney can come up with suitable alternatives to settle your judgment, bankruptcy would protect IRA assets up to $1 million from creditors.
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