Roth IRAs & Bankruptcy
As of 2005, individual retirement accounts, including Roth IRAs, are protected from bankruptcy. Therefore, if a person declares Chapter 7 bankruptcy, they are not obligated to give up their IRA assets as part of the bankruptcy agreement. Although other retirement accounts had been protected for decades, IRAs only recently received federal protection. As a result, IRAs--specifically Roth IRAs--have become increasingly popular.
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What Is a Roth IRA?
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A Roth IRA is a specific type of retirement savings account. A traditional IRA allows contributions to be tax-deducted, but the retiree will pay taxes upon withdrawal. Conversely, a Roth IRA requires the owner to make post-tax contributions, but no taxes are taken out on the earnings or upon a normal withdrawal.
Roth IRAs are intended to help middle- and low-income families save for retirement, so there is an income cap. Typically, single people can contribute to a Roth IRA only if they make less than $120,000 per year, and married couples can contribute only if they make less than $176,000.
Bankruptcy-Protected Assets
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Typically, when a person files for bankruptcy, most of his assets are seized. However, there has long been legal protection for various types of assets. Alimony and child support, disability and unemployment benefits, and a percentage of wages are all shielded. Pensions and 401(k)s are also protected. A 2005 court case and subsequent law deemed Roth IRAs protected against seizure as well.
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Rousey v. Jacoway
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In the 2005 case Rousey v. Jacoway, a couple argued that their IRA accounts should be shielded when they filed for bankruptcy. The U.S. Supreme Court ruled unanimously in the couple's favor, making IRAs protected assets for the first time. The court based its decision on the fact that the IRA money was not available to the couple at that time without penalty (since they were not yet of retirement age). Therefore, IRAs should not be counted as assets for seizure.
Bankruptcy Abuse Prevention and Consumer Protection Act
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Shortly after the Rousey Supreme Court decision, Congress provided further clarification on the issue of bankruptcy in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, or BAPCPA.
Although 401k and 403(b) retirement accounts had been granted bankruptcy protection in 1974, IRAs had not. BAPCPA provided similar bankruptcy protection to both traditional and Roth IRAs. Now, when a person files for bankruptcy, IRA funds cannot be seized.
IRAs are protected only against bankruptcy. The assets can still be seized as a result of a civil lawsuit, for example.
Roth vs. Rollover IRA Protection
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BAPCPA did put a cap on the bankruptcy protection, however. Roth IRAs assets only up to $1 million are shielded from bankruptcy. Because of the low yearly contribution limits to Roth accounts, it is unlikely that many account holders could have more than $1 million in their Roth IRA.
Rollover IRAs, on the other hand, are not subject to the $1 million cap. Rollover IRAs are protected from bankruptcy in their entirety, regardless of value.
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