Can Retirement Accounts Be Used As Collateral?

Qualified retirement plans don't usually make good collateral.
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Retirement accounts include qualified employer plans, nonqualified employer plans and individual retirement accounts. Qualified employer plans include 401(k)s, 403(b)s and 457s. These plans allow you to deduct your contributions. Nonqualified employer plans, such as deferred compensation plans and executive bonus plans, don’t provide tax deductions. As long as the plan permits it, you can borrow from an employer plan or pledge it as collateral, subject to certain restrictions involving “disqualified persons.”

Pledging an IRA

A traditional IRA offers tax-deductible contributions and tax-deferred growth of your investments. You must pay taxes on withdrawals and might have to pay a 10 percent penalty on withdrawals before age 59 1/2. A Roth IRA provides no tax deductions but does offer tax-free growth and withdrawals after owning the account for five years and reaching age 59 1//2. However, you can withdraw Roth contributions tax- and penalty-free at any time. The Internal Revenue Service doesn't permit you to borrow from an IRA or to use it as collateral. If you do so, the IRS will no longer consider the account an IRA and will tax it as if you withdrew all the money on January 1. This also might result in the early withdrawal penalty if you're under the age of 59 1/2. These rules also apply to SEP IRAs and SIMPLE IRAs.

Pledging a Qualified Plan

The rules for pledging a qualified plan -- that is, using it as collateral -- are set down in IRS Regulation 1.401(a)-13(d). Under this regulation, you can pledge the “accrued nonforfeitable benefit” of your account if your qualified retirement plan allows loans and the loan or pledge is not made to a disqualified person. The IRS's definition of disqualified persons includes those controlling or providing services to the plan, the employer, an employee organization with members covered by the plan, majority stockholders of the employer and family members of disqualified persons. Certain exceptions allow loans and pledges to disqualified persons who are plan participants or beneficiaries.

Protection From Collection

Even if it’s legal to pledge your qualified employer plan as collateral, lenders might be reluctant to accept this collateral. The Employee Retirement Income Security Act of 1974, or ERISA, protects qualified employer plans from collection by creditors. This means that even if you pledge your 401(k) to collateralize a loan, the lender can’t seize your plan if you default on your loan. However, this protection doesn't necessarily apply to cases involving family members.

Qualified Domestic Relations Order

If you pledge your qualified plan to certain family members, a state court can issue a qualified domestic relations order, or QDRO, that allows the family member to seize the collateral. The family member can be a spouse, ex-spouse, child or other dependent. QDROs normally cover disputes regarding child support, alimony or marital property rights. You don’t have to borrow from or pledge your qualified employer plan for the plan to be seized via a QDRO. ERISA protection doesn't extend to nonqualified employer plans.

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