Your pension, 401(k), IRA or other retirement benefits may be a large part of your personal wealth, becoming increasingly important as you near retirement. These assets may be the most important part of your individual wealth building strategy. Are such assets safe from creditors who may seek to garnish or seize your retirement benefits?

The answer is that your assets held in retirement plans are generally safe from creditors, even if you are involved in a bankruptcy action. Your creditors cannot simply go to your retirement plan and demand money from your account. Retirement plans have provisions preventing creditors from seizing your benefits in them. However, exceptions exist to this general rule, and creditors may reach your retirement plan benefits in some limited circumstances.

First, one must understand the protection that federal pension law offers against creditor action. Most private employer retirement plans are governed and protected by a federal pension law known as the Employee Retirement Income Security Act of 1974 ("ERISA").

ERISA requires pension plans to have "spendthrift" provisions which prevent benefits from being alienated from the participant. What this means is that you are protected from both your creditors and your own desire to spend the money before you retire or are otherwise able to under the terms of the plan.

Specifically, ERISA's anti-alienation provision requires that all pension plans contain provisions which provide that benefits may not be assigned to a creditor. The IRS has also ruled that if a pension plan allows benefits to be alienated from the pension plan to pay creditors, the pension plan itself will lose its favorable tax status.

The U.S. Supreme Court has decided that ERISA-covered retirement plan benefits are protected from creditors in bankruptcy. However, local federal courts have interpreted this decision to mean that in order for pension benefits to be protected, three requirements must be satisfied. First, the pension plan must be subject to ERISA; second, the pension plan must be tax-qualified under certain IRS rules; and third, the pension plan must contain a written anti-alienation provision. While most pension plans meet these requirements, it is important to note that a pension plan covering only the owner, or the owner and spouse, is not considered to be an ERISA plan. Thus, the benefits in such a plan may fall outside of the protection of the Supreme Court decision should the participant enter bankruptcy.

Other limited exceptions to ERISA's anti-alienation rules exist. The most common one is when someone is involved in a divorce action and one spouse claims part of the other spouse's pension. A 1984 federal law allows assignments of pension benefits pursuant to a qualified domestic relations order. This is a state judgment order entered into in connection with a divorce, alimony payments or child support proceedings under state domestic relations law.

Federal tax liens are another important exception to ERISA's anti-alienation rules. Federal tax liens can attach ERISA pension plans. One issue here is whether the IRS can immediately seize pension benefits, or if it has to wait until the participant may take a distribution. The IRS has generally been successful in persuading federal courts to allow it to immediately seize the pension to pay off the tax lien. However, state tax liens cannot attach ERISA pension plans.

ERISA's anti-alienation protection will not protect benefits once they have been distributed outside of the retirement plan.

In contrast to retirement plans, IRAs are maintained by individuals and are not governed or protected by ERISA. SEPs, or Simplified Employee Pensions, are similar to IRAs except they are set up by small employers. Like IRAs, SEPs are not protected by ERISA. IRAs and SEPs also contain spendthrift provisions, but most courts have not given IRAs and SEPs protection against garnishment. The previously mentioned Supreme Court decision protecting pension benefits does not extend to IRAs or SEPs because they are not covered by ERISA.

Some states have enacted laws to protect IRAs, SEPs and non-ERISA retirement benefits from creditors, but legislation introduced in Ohio to fully protect IRAs, SEPs and non-ERISA retirement benefits has not been enacted into law. Ohio law currently protects IRAs only to the extent reasonably necessary for the support of the participant. Thus, a critical difference between ERISA covered retirement benefits and IRAs, SEPs, and non-ERISA retirement benefits is protection from creditors when the participant is in bankruptcy action.

ERISA's anti-alienation protection rules do not apply to employee welfare plans, nor do they apply to the increasingly popular non-qualified plans. Non-qualified plans are usually designed for key executives. Unlike a traditional tax-qualified pension plan, the assets of a non-qualified plan are considered to be part of the sponsoring corporation's general assets until the assets are actually paid to the key executive. The assets of a non-qualified plan are thus subject to the demands of the creditors of the corporation sponsoring the non-qualified plan.

In conclusion, retirement plans should be an important part of your personal wealth-building strategy. Not only do they provide one of the few remaining tax deferral mechanisms, but in most cases retirement plan benefits are given safe haven from creditor action.

This article was written for a general employee benefits audience. For a more detailed discussion of the issues presented here, you may want to review:

• William P. Brown, Patterson Protection of Plan Interest: Shield or Sieve?, Journal of Pension Planning & Compliance, Spring 1995; and
• Carla Michele Schiff, Protecting Non-ERISA Pension Funds from the Reach of Creditors in Bankruptcy, Bankruptcy Developments Journal (student note), 1994-95.

Copyright 1995 Robert S. Melson