Individual retirement accounts are not entirely safe from lawsuits. While the federal government provides special protections for company-sponsored 401(k) plans, each state has its own rules for IRAs. Many states allow a judge to determine how much can be awarded in a court ruling from a person's retirement plan. The amount can vary by judge.
Supreme Court Ruling
The U.S. Supreme Court ruled in 2005 that traditional and Roth IRAs assets generally are protected from lawsuits. However, the court left an important issue unresolved when it said IRA money is shielded only to the extent of what might be considered "reasonably necessary" to support the IRA owner and his or her dependents. The ruling allows any amount of money above and beyond that amount to be seized in a lawsuit, depending on the laws in that state. However, the ruling generally allows individual judges to decide what is reasonably necessary.
Most states provide enough protection to keep people from being wiped out by a lawsuit. For example, judges in California cannot award money from someone's retirement plan that the person would "reasonably" need to live on. Other states like New Hampshire and Mexico have no laws specifically addressing how IRAs are protected in lawsuits. However, Texas, Arizona and Washington have some of the strongest protections for owners of IRAs who are facing lawsuits. Arizona only allows contributions to the IRA made within the last 120 days to be subject to creditor's claims in a bankruptcy.
Employer-sponsored 401(k) plans are safe from lawsuits. Only the Internal Revenue Service or a spouse can make claims on that money. Employer-sponsored accounts are protected by the Employee Retirement Income Security Act. Congress authorized 401(k) plans to help employees have some money to fall back on when their working days are done. Federal lawmakers gave these retirement plans special protections for this reason.
To add insult to injury, you must still pay taxes on the IRA withdrawal and suffer a 10 percent early withdrawal penalty if you are under age 59 1/2. It doesn't matter if you are making the withdrawal because of a lawsuit. Also, if you are 70 1/2 and are withdrawing required amounts from a traditional IRA, you must continue to do so. The required minimum withdrawal rules set by the IRS do not change because of a lawsuit.
Tim Grant has been a journalist since 1989 and has worked for several daily newspapers, including the Charleston "Post & Courier," the "Savannah News-Press," the "Spartanburg Herald-Journal," the "St. Petersburg Times" and the "Pittsburgh Post-Gazette." He has covered a variety of subjects and beats, including crime, government, education, religion and business. He graduated from The Citadel with a Bachelor of Science in business administration.