Do IRA and 401K Differ in Terms of Creditor Protection?

Both IRA and 401K are what’s called Qualified Accounts.
Qualified Accounts have no Medicaid/Long-term Care protection.
If you were to need Nursing Home Care, anything inside your IRA or 401k would have to be spend down, whether it’s in your name or in your spouse’s name. They are both countable assets, meaning they count towards that nursing home or Medicaid protection.
But what they do offer is a form of creditor and bankruptcy protection.
But there is a difference. 401k falls under ERISA, so they fall under Federal, while IRA falls under State Law.
Another interesting distinction is that IRA’s is protected up to $1.3 million from creditors and bankruptcies, while 401k’s have unlimited protection.
So if protection from bankruptcy and asset protection is very important to you then maybe that is a reason why to keep money inside a 401k.Keep in mind that even though you do have this Creditor Protection, it does not apply to the IRS nor does it protect from spousal claims. Another easier option if liability or creditors are concerned would be to get Umbrella coverage. Typically you will get a million-dollar worth of coverage for maybe $200 a year.

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Episode Transcript

IRA and 401(k) Distinction

Do IRAs and 401(k)s differ in terms of creditor protection?

Welcome to Berry’s Bites. Please join our host, Attorney and Financial Advisor, Chris Berry.

So both of these accounts, both IRAs and 401(k)s are what’s called qualified accounts. Qualified accounts, one thing to keep in mind is that there is no Medicaid/long-term care protection for either one of these accounts. So, if you were to need nursing home care, anything inside of your 401(k), IRA, et cetera, would have to be spent down. Whether it’s in your name, whether it’s in your spouse’s name, those are all countable assets, meaning they count towards that nursing home or Medicaid protection. But what they do offer is a form of creditor and bankruptcy protection. And there is a difference. The difference is that 401(k)s fall under ERISA, so they fall under federal. IRAs fall under state law.

 

Creditor Protection

And here’s a little interesting distinction is, IRAs are protected up to a $1.3 million from creditors and bankruptcies, 401(k)s have unlimited protection. So, if protection from a bankruptcy is something that’s super duper important to you, then maybe that is a reason why to keep money inside of a 401(k). But keep in mind, either way to get that type of protection, you would still have to go through a bankruptcy, which could be a big pain in the butt, right? Another easier option if liability or creditors are concerned would be to getting umbrella coverage, like an umbrella policy through your property and casualty guy. Typically, you’re going to get about a million dollars worth of coverage for maybe $200 a year. So it’s super cheap.

So, if I guess protection from creditors, not Medicaid or nursing home is a big concern, I almost wouldn’t want to rely on the bankruptcy protection. I’d rather just pay a couple extra hundred bucks a year to build in that umbrella protection, okay? But yes, you do have more asset protection inside of a 401(k). So maybe if your big concern is asset protection, maybe that’s a reason why to move that IRA into a 401(k). But I guess there’s different ways to do that and first I’d look to something that wouldn’t force you to go through a bankruptcy. I would look at maybe umbrella protections. And keep in mind, even though you do have this creditor protection, it does not apply to the IRS nor does it protect against kind of spousal claims. So whether it’s in a 401(k) or IRA, understand that it’s not protected for long-term care purposes, it’s not protected for any IRS issues. You don’t want to mess with the IRS and any type of spousal/divorce issues. Either way, whether it’s 401(k) or IRA, it’s not necessarily protected.

 

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