401(k) protected from IRS debt?

[Chrisfs]

Hi all,

An extended family member came to me with this question.
Is a 401(k) plan protected from creditors? As far as I can tell the answer is 'yes' for regular creditors, but I was unsure about the IRS, since they are sometimes an exception.

Hope you all have been doing well.

[bmielke]

Hi all,

An extended family member came to me with this question.
Is a 401(k) plan protected from creditors? As far as I can tell the answer is 'yes' for regular creditors, but I was unsure about the IRS, since they are sometimes an exception.

Hope you all have been doing well.

I read here that a member had their 401K wiped out by the IRS in another thread. So I don't think it's protected, but can't site statutes to back that up.

[Nikki]

Not only can the IRS levy against the accounts, but the account holder can get hit for both the early withdrawal penalty and the income taxes due on the withdrawal.

Much better to pay the taxes in the first place.

[Evil Squirrel Overlord]

It is not protected from regular creditors.

[Quixote]

Not only can the IRS levy against the accounts, but the account holder can get hit for both the early withdrawal penalty and the income taxes due on the withdrawal.

Much better to pay the taxes in the first place.

The amount withdrawn due to an IRS levy is not subject to the 10% tax on early withdrawal. See exception 10 for line 2 in the instructions for Form 5329.

[Nikki]

My bad. Missed that one. Thanks.

[Cpt Banjo]

It is not protected from regular creditors.

It is in some states. See http://www.latimes.com/la-ira-story3,0,6977190.story

[sullinsea]

Whether 401(k) account assets are exempt from regular creditors is first a function of state law and the Bankruptcy Code. Here in WA we have very strong protection of such assets.

http://apps.leg.wa.gov/rcw/default.aspx?cite=6.15.020

Under the IRC 401(k) accounts are no exempt.

http://www.law.cornell.edu/uscode/26/us ... -000-.html

However, the non-binding policy of the IRS is to generally not levy on 401(k) or IRA assets unless there are "extraordinary circumstances."

http://howardlevyirslawyer.com/document ... n_take.pdf

[jg]

From the above linked article in regard to levy of retirement plans:

If your client contributed to the retirement account while the unpaid taxes were accruing, the IRS will consider the liability to be based on flagrant conduct. A history of severe employment tax problems is also considered to be flagrant. An individual who continues to incur trust fund taxes or was found to be responsible for the Trust Fund Recovery Penalty on more than one occasion has a high risk of losing a retirement plan to the IRS.
Other examples of flagrant conduct that could result in the seizure of retirement
accounts include uncooperative or unresponsive behavior (failing to meet established
deadlines, to attend scheduled appointments, or to respond to Revenue Officer attempts to
make contact). Those who make frivolous arguments that taxes are illegal or
unconstitutional or are involved in tax fraud or tax evasion are obviously involved in
flagrant conduct.

To me, it is not so "extraordinary" to continue to contribute to a plan while the unpaid taxes were accruing. Just one man's opinion, yours may vary significantly.

[Pottapaug1938]

When I was in the retirement plans section of my company, I remember seeing many a levy on retirement plans, not only by tax people but also by child support agencies.

[Prof]

Those states which exempt retirement plans often have exceptions for child support. Of course, in a divorce, in a community property state, the spouses are generally required to split all retirement assets unless the assets are separate property.

The 2005 amendments to the Bankruptcy Code may also impose limits on retirement plans, particularly where the debtor moves from a state with limited exemptions to one, like Texas, with extraordinary exemptions.

[Pantherphil]

Agree that 401(k) plans are subject to levy. The Internal Revenue Manual does provide some administrative limitations and approval requirements before levy of a 401(k) can be authorized in recognition that a levy on a retirement plan account can cause serious financial hardship.

With respect to claims from other creditors, a 401(k) plan is a qualified retirement plan under Code Section 401(a) and a pension benefit plan under ERISA. As a result, assets of the Plan have to be held in qualified trust accounts which are, generally, exempt from claims and levies of general creditors while in the hands of the Plan trustee. There is a specific provision for "qualified domestic relations orders" or QDROs which can be used in divorce or child support cases to collect amounts due for support. Each qualified plan has to have a policy for handling qualified domestic relations orders.

Some state laws permit IRA accounts and employee voluntary contributions to a 401(k) plan to be attached or taken on trustee process or levy of execution to the extent that the employee has the right under the Plan to withdraw them. This concept comes from the idea that a person should not be able to create a "self settled" spendthrift trust to avoid creditors.

Many states have a statutory exemption from levy or trustee process for IRA or retirement plan payments or accounts. In my State of Maine, the exemption for retirement plan payments and accounts is in 14 M.R.S.A. Section 4422. There is also a specific bankruptcy exemption for certain retirement accounts and benefits in 11 U.S.C. Section 522.

Pretty complicated stuff. Always best to consult a knowledgeable expert in the State in question.