Individual retirement accounts (IRAs) are a type of retirement account that provides tax advantages. Traditional IRAs allow you to deposit pre-tax dollars in the account, and you do not get taxed on those funds until you withdraw the money. The funds can be withdrawn penalty-free after age 59 1/2, although income tax still applies. Federal law does not address the issue of whether creditors can touch your IRA savings. In Connecticut, your IRA funds are garnishment-proof, as of 2011, as long as you leave the money in the account. However, you may be subject to collection action if you withdraw it before resolving your credit problems. IRAs are automatically exempt in Chapter 7 bankruptcy cases in Connecticut.
Employment Retirement Income Security Act
The Employment Retirement Income Security Act is a federal law that protects money in most retirement accounts from most creditors and debt collectors. The federal law does not exempt traditional IRA or Roth IRA funds, however. Connecticut law states, however, that debt collectors and creditors may not garnish money that is deposited in a retirement account such as an IRA to satisfy an outstanding debt. The IRS and former spouses are exceptions to this law. The IRS can garnish retirement funds if you owe back taxes, and former spouses can request that the court garnish retirement accounts if you owe spousal or child support.
If you file for Chapter 7 bankruptcy in Connecticut, your IRA funds are automatically exempt. Thus, your trustee cannot liquidate your IRA to pay off your creditors after you file for bankruptcy. You must list your IRAs and the amounts in them on your bankruptcy paperwork even though they are exempt in the interest of full disclosure of your assets.
If you receive distributions from your IRA, these may not be exempt from creditors. Connecticut allows you to exempt only the money you need to live on once you make withdrawals from your IRA. Thus, you may wish to leave funds in your IRA or roll them over to a new retirement plan if you change employers so that you do not risk creditors seizing your retirement funds after you withdraw them.
If you leave your IRA funds to a beneficiary, the beneficiary will not have to wait to go through probate before receiving the account. However, most beneficiaries have to receive their first payment from your IRA by December 31 of the year you die, according to elder law attorney Robert Clofine. Therefore, if your beneficiaries have credit problems, the funds will not be exempt from being garnished by their creditors because of Connecticut's lack of protection for most IRA withdrawals.