Your golden years will not be the relaxing, stress-free time that you envision unless you start planning for retirement early. The U.S. Department of Labor explains that individual retirement accounts, often referred to as IRAs, are special accounts reserved specifically for your retirement savings. Both workers and their employers can make contributions to an employee’s IRA. The money then earns interest until you cash out your IRA and retire. Unfortunately, if you neglect to pay off certain debts, your IRA may not be there for you when you’re finally ready to use it.
Any retail creditor, such as a hospital, department store or credit card company, can file a lawsuit against you if you leave your debts unpaid. If a creditor wishes to sue, it must sue you and not accounts you own. For example, a creditor cannot file a lawsuit directly against your IRA, meaning the lawsuit names the IRA in question as the defendant. Even if the creditor knows how much money you have in the account, it cannot file its lawsuit directly against the IRA to claim the funds the account contains.
When a creditor wins a lawsuit against you, you can be forced you to pay off the debt you did not pay voluntarily. While state laws differ regarding the specific collection rights judgment creditors have, they can generally collect debt by garnishing or seizing non-exempt assets. Whether or not your IRA is protected from judgment creditors depends solely on your state’s laws. Certain states, such as New York and Connecticut, protect 100 percent of the funds consumers deposit into their IRAs. If IRAs are exempt in your state, judgment creditors cannot seize them.
If your state’s laws prohibit judgment creditors from seizing or garnishing your IRA, you won’t lose your retirement savings over a commercial debt, but you could still lose your IRA over debts you owe to the federal government. The Internal Revenue Service, for example, has the right to seize assets that are typically exempt from seizure, including your IRA. Unlike other creditors, the federal government does not need to win a lawsuit against you before seizing your assets.
State laws dictate what portion of your IRA is exempt both before and after you cash it in. Thus, your state laws may prevent creditors from seizing your retirement savings while it is contained within the IRA, but offer the funds no protection once you cash out the account. Should this occur, a creditor with a valid judgment against you could seize the money via a bank levy as soon as you deposit it into a standard bank account.
- U.S. Department of Labor: What You Should Know About Your Retirement Plan
- Neighborhood Economic Development Advocacy Project: Debt Collection Basics
- University of Minnesota Extension; Rights of Unsecured Creditors; Phillip L. Kunkel; et al.
- "The New York Times"; Protecting Retirement Accounts from Creditors; Deborah L. Jacobs; April 2009
- U.S. Department of the Treasury; Answers About Garnishments; June 2011
- Photo Credit BananaStock/BananaStock/Getty Images