Is my IRA Protected in Bankruptcy?

 When considering filing for bankruptcy, many individuals are concerned that their individual retirement account, or IRA, will not be protected.  Typically, IRAs are protected through bankruptcy; however, there are certain instances when an IRA could be considered unprotected. 

 The bankruptcy code states that IRAs are protected through bankruptcy, but only if the funds are in an account that is exempt from taxation. Generally, your IRA will remain exempt from taxation, unless you have used the money in your account in a way that is prohibited by the IRS.  The Internal Revenue Code has rules that restrict what can be done with your IRA, and these rules list “prohibited transactions”; Committing one of the prohibited transactions could make your account taxable, meaning it would NOT be exempt from taxation.  

 Examples of prohibited transactions include:


  • using the money in the account to benefit a disqualified person (meaning yourself, your family, or your business/employees)


  • selling, leasing, or exchanging the property in the account with a disqualified person


  • lending the money or extending credit from the IRA to a disqualified person


The basic rule with an IRA is that you cannot receive any benefit from the money in your IRA unless it is authorized by the plan and by the law.  If your account is managed by an independent custodian (someone other than you who is impartial), engaging in prohibited transactions do not typically occur because this person will not allow them to.  However, if there is not an independent custodian of the account, you can run into trouble.  Many times, people will run into this when dealing with real estate and with attempting to roll over their account into a new account.  


As an example, you cannot use your IRA as collateral for a loan to purchase real estate.  This is prohibited by the IRS, and will lead to your account losing its tax exempt status. 


Another example of a prohibited act would be when you are rolling over your IRA from one company to another.  Many companies have a simple form that will transfer your account without you needing to do anything personally.  However, you also have the option to withdraw all of the funds from the account and transfer them yourself into the new account.  When doing this, you have 60 days to complete the roll over to the new account.  Many people are tempted, however, to take or borrow money out of the IRA during this 60 day window.  Doing this is prohibited by the IRS, and will lead to your account losing its tax exempt status. 


Because the IRS does not have the time or the man power to audit every single person in the United States with an IRA, many people can commit these “prohibited transactions” without ever getting caught.  Additionally, knowing that the risk of getting caught by the IRS is typically slim, many people are tempted to pull from their IRAs or use them in a way that would make them unexempt from taxation.

This is when your IRA would become unprotected when filing for bankruptcy. Despite the IRS not having the time to audit your account, the Bankruptcy Trustee most likely will.  This is because the Bankruptcy Trustee has a vested interest in finding funds to disperse to your creditors, since he or she will get a cut of that money as well.  If the Bankruptcy Trustee does an investigation of your IRA and finds that there have been prohibited transactions, he or she will object to your claim that it is protected, since the IRA will have lost its tax exempt status.  Then, if the Trustee’s objection is successful, he or she will be able to obtain the account to disperse the funds in it to your creditors. 

As stated before, typically, your IRA will be protected during your bankruptcy; however, there are some exceptions.  If you have an IRA, and you are certain that you have not engaged in any prohibited transactions, your IRA will be protected. However, if you have engaged in prohibited transactions, you could face losing your IRA by filing for certain types of bankruptcy. 

If you have questions about your IRA being protected, contact a St. Louis bankruptcy attorney today.

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