“How to Safeguard Your Retirement Savings in Legal Disputes”

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What Happens to Retirement Accounts if You’re Sued?

If you’re facing a lawsuit from unpaid creditors, a car accident victim, the IRS, or a co-parent to whom you owe support, the impact on your finances can be significant. Assets like rental properties or vehicles might be liquidated to cover damages if your cash assets or insurance fall short. However, certain retirement accounts may be protected. Understanding federal and state regulations regarding your 401(k) and IRA accounts is crucial if you’re worried about their safety in a lawsuit. Here are the basics.

Employer-Based Retirement Plans

Employer-based retirement plans covered under the Employee Retirement Income Security Act (ERISA)—including most 401(k), 403(b), and profit-sharing plans—are protected from seizure by federal law. For instance, if you default on credit card bills, your creditors cannot go after your retirement funds, regardless of your state of residence. However, ERISA-qualified retirement funds may be accessed if you owe money to the IRS or are involved in disputes over child support, alimony, or asset division in a divorce.

IRAs

Unlike employer-based retirement plans, individual retirement accounts (IRAs) are not federally exempt in a lawsuit. This is because ERISA-qualified retirement accounts are technically owned by your plan administrator, not you. You don’t own the funds until they’re withdrawn. An IRA, however, is funded directly by you, and you retain ownership of the money at all times.

State laws vary widely in protecting IRA funds. For example, in California, protection only extends to the amount necessary to support you, your spouse, and family at retirement, considering all your assets. In Hawaii, the exemption doesn’t apply to funds deposited within the past three years. Consult your attorney to understand how your retirement funds may be affected and whether there are steps you can take to protect your money.

Can Creditors Go After Your Retirement Accounts?

While commercial creditors typically can’t touch your 401(k), they may be able to garnish an IRA. Protections against creditors for retirement accounts are similar to those described above: ERISA-qualified retirement plans are usually fully protected, while IRA protections vary by state.

If you have an independent 401(k) due to self-employment, your retirement account can be seized in a civil lawsuit in some states. It’s advisable to check with an attorney if you have an account that isn’t fully protected from creditors and you’re facing a lawsuit.

How to Protect Your Assets From a Lawsuit

What about assets that aren’t held in retirement accounts? You may be able to reduce the risk to your personal assets in a lawsuit by increasing your insurance coverage, structuring and insuring your business as a separate entity, and considering using an irrevocable trust to hold your assets. Here’s how these work:

Umbrella Insurance

An umbrella insurance policy provides additional liability coverage that goes beyond the limits of your personal auto and home policies. This added coverage makes it less likely a lawsuit covered under your home or auto policy will dip into your retirement funds or affect your other assets. However, umbrella policies typically don’t cover business activities, intentional or criminal acts, or injuries you sustain yourself. To protect business activities, you’d need a commercial umbrella policy.

LLC or S Corporation

If you’re self-employed, you may want to register your business as a limited liability company (LLC) or an S corporation to help protect personal assets in the event your business is sued.

Malpractice Insurance

Doctors, lawyers, and other professionals may want to carry separate malpractice insurance to protect personal assets from malpractice suits. In some professions and states, you may be required to have malpractice insurance to maintain your license.

Asset Protection Trust

Setting up and funding an irrevocable trust may protect your assets from creditors and lawsuits. When you move your assets—such as stocks and bonds, real estate, and artwork—to an irrevocable trust, you transfer ownership to the trust. Since you no longer own the assets, they can’t be considered in a lawsuit against you. However, you’ll face legal repercussions if you sign an irrevocable trust with the intention of defrauding creditors.

The Bottom Line

Whether you’re planning to retire in the future or living off retirement savings now, it’s worth taking the time to understand how you can protect your retirement accounts in a lawsuit. Discuss your options with an attorney who can give you the details on federal and state laws that apply in your case.

If you’re concerned about the possibility of creditors taking you to court, you may also want to learn more about negotiating with debt collectors when you’re having trouble paying your bills, going through credit counseling, or considering bankruptcy. For an overview of the status of your credit accounts, download a free copy of your credit report. Wherever possible, avoiding a lawsuit may be the best option of all.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with confidence.

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