What this article covers
Opher Ganel explains why 401(k) money enjoys unlimited protection in bankruptcy while IRAs are protected only up to an inflation-adjusted cap (about $1 million when the law passed in 2005), and the one rollover mistake that can quietly move old 401(k) money from the first category to the second. He lays out three ways to keep the unlimited exemption after leaving a job, and seven financial advisors add the tax, loan, divorce and account-management factors to weigh before deciding.
Key Takeaways
Rolling an old 401(k) into an IRA that holds other money can cost it unlimited bankruptcy protection
Under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), 401(k)s, 403(b)s and other employer plans, plus IRAs funded solely with rollovers from them, are excluded from your bankruptcy estate without limit. Mix that rollover into an IRA that also holds regular contributions and the whole account falls under the IRA cap, which started at $1 million and is adjusted for cost of living every three years.
You can keep the unlimited exemption by leaving your 401(k), moving it to a new employer’s plan, or using a rollover-only IRA
Opher Ganel names three options: leave the money in the old plan, roll it into a new employer’s 401(k) if the plan allows, or roll it into a new IRA (or one that holds only prior 401(k) rollovers). He also notes that staying in an employer plan can let you legally avoid RMDs on non-Roth 401(k) money while you work for a company you own no more than 5% of.
Creditor protection isn’t the only factor in a 401(k) rollover decision
Advisors point out that pre-tax IRA money can trigger the pro-rata rule on backdoor Roth conversions, that an outstanding 401(k) loan may become a taxable distribution, and that mixing premarital and marital money can matter in a divorce. Others warn that old plans may cash out small balances unexpectedly and that scattered accounts get harder to manage over time.
Stephan Shipe
Nathan Mueller
Amanda Howerton
Jen Swindler
Freeman Linde
Douglas GreenbergAvoid the one mistake people make that can expose your 401(k) money…
Do you have a 401(k) account?
It’s almost as likely as not.
According to Statista, there were 133 million employees in the US in September 2022, and the Investment Company Institute (ICI) says there were 60 million active 401(k) participants that month, or 45% of all employees.
If you’re one of those 60 million, there’s something you should know.
While a 401(k) account can’t be taken from you as a result of a lawsuit, there’s one mistake you must avoid or (some of) your 401(k) money may be exposed to lawsuits.
Is Your 401(k) Protected From Creditors and Bankruptcy?
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was passed, making filing for bankruptcy under Chapter 7 rather than Chapter 13 more difficult. BAPCPA also put in place protections for money held in qualified retirement plans.
According to the Benefit Financial Services Group, “Under BAPCPA, assets held in all qualified plans (such as 401(k), profit sharing, thrift, money purchase, ESOP, and defined benefit plans), 403(b) plans, and state and local government-sponsored 457 plans are expressly excluded from the bankruptcy estate… Assets in traditional and Roth IRAs are protected up to a $1 million limit, without regard to rollover amounts.”
Note however, according to Lord Abbett, one of the oldest money management firms in the US, “BAPCPA draws no distinction between owner-only retirement 401(k) plans and other qualified retirement plans with respect to bankruptcy exemption. Outside bankruptcy, however, it appears that owner-only plans may be subject to attachment by creditors.” (my emphasis)
As for traditional and Roth IRAs, those were protected up to $1 million in 2005, with a cost-of-living adjustment (COLA) once every three years. As of this writing, that limit stands at $1,512,350.
Note that 401(k) money is not protected against tax liens or your spouse (who is considered a co-owner of those monies).
The 401(k) Rollover Mistake That Can Expose Your Money to Creditors
Aside from failing to maintain a great relationship with your spouse and the IRS, the big potential gotcha that could expose at least some of your 401(k) money to judgments is how you roll it over after leaving your employer.
BAPCPA offers an unlimited exemption from your bankruptcy estate for your 401(k), 403(b), and other employer-sponsored retirement plans, as well as for any IRAs that were funded solely by money rolled over from such employer-sponsored accounts.
However, if you roll such 401(k) money into an existing IRA that held money not rolled over from such accounts, it loses that unlimited exemption.
In that scenario, your IRA is only protected up to the (COLA-adjusted $1 million IRA exemption).
Thus, while it may somewhat simplify your finances to not open a new IRA for the rollover, that simplicity may cost you dearly down the line.
3 Ways to Keep Your Old 401(k)’s Unlimited Bankruptcy Protection
Here are 3 ways to maintain the unlimited exemption for your old 401(k) money.
- Leave it where it is.
- Roll it over into your new employer’s 401(k) (if allowed).
- Roll it over into a new IRA (or an established one that has only money from prior 401(k) rollovers).
What are the pros and cons of each of these?
Here’s a table that summarizes them:
Note especially that you can legally avoid RMDs even on your non-Roth 401(k) balance as long as you remain on the payroll of a company you don’t own or one where your ownership is no more than 5% of the company.
Stay connected
See more of Wealthtender when you search Google
Add us as a preferred source, and our guides to personal finance and choosing a financial advisor can appear more often in your Google results, with a “Preferred” label in AI Overviews.
What Else Should You Weigh Before Rolling Over an Old 401(k)?
The above aren’t the only considerations.
Stephan Shipe, PhD, CFA, CFP®, Owner & Lead Advisor at Scholar Financial Advising, LLC cautions:
Specifically for high earners, rolling 401(k) money into an IRA can make future Roth conversions run into the pro-rata rule. This is a common issue for those looking to perform a ‘backdoor’ Roth conversion because having any pre-tax dollars in any IRA leads to a taxable event when converting new after-tax IRA money into a Roth IRA.
Nathan Mueller, MBA, Financial Planner and Financial Coach at Blackbird Financial Planning points out two additional important details:
Rolling over into an IRA often makes sense. It provides more investment options, and the money is in your name. I’ve seen companies go through bankruptcy where employees’ retirement accounts were frozen until the bankruptcy court determined if employees got to keep their retirement savings.
However, I don’t always recommend rolling into an IRA. For example, if you roll over a 401(k) account with an outstanding loan, the remaining balance on the loan is considered a distribution and may be subject to a penalty and taxes.
Amanda Howerton, Senior Advisor at Rather & Kittrell adds two more considerations:
If the 401(k) is pre-marriage/separate property and the IRA is considered marital property (or vice versa), you may want to keep them separate in case of divorce. Once you comingle monies, all the money will be considered marital property and will likely get divided if you divorce.
Before a rollover, consider establishing a Roth IRA for any post-tax/Roth 401(k) dollars. This allows the new Roth IRA to grow tax-free with eventual tax-free distributions.
P. Timothy Uihlein, CFP®, MBA, Partner, Managing Director, and Senior Wealth Manager at Vincere Wealth Management says:
One major reason I advise clients not to roll over an old 401(k) to an IRA is losing loan privileges (if the old plan allows it). While often the terms aren’t ideal, it offers a solution to address a short-term liquidity issue.
Jen Swindler, CFP®, AFC®, Senior Wealth Manager also at Vincere Wealth Management, cautions against leaving 401(k)s with old providers, especially for smaller balances, “I’ve seen many people unexpectedly receive a distribution check from a prior 401(k) plan. They often don’t understand why they’re receiving it, sometimes cash it, and then later owe taxes and a penalty.”
Freeman Linde, CFP®, La Crosse Financial Planning offers a final caution:
Most people should avoid leaving an old 401(k) account as is. The more time passes from when you leave that job, the harder it gets to manage the money. HR departments change and your former employer may switch 401(k) providers. Keeping your money consolidated into as few accounts as possible makes it easier to manage.
How Many Americans Have More in Retirement Accounts Than the IRA Bankruptcy Exemption?
The Washington Post reported that according to Fidelity Investments, it had nearly 300,000 401(k) millionaires at the end of 2022, compared to 442,000 a year earlier.
They also showed about 280,000 IRA millionaires, a 25% drop from the end of 2021.
However, the S&P 500 (total return, including dividends), which dropped 18.1% from the end of 2021 to the end of 2022, was back up at the end of July 2023 to just 1.2% below its value at the end of 2021.
Thus, we can extrapolate the number of Fidelity 401(k) millionaires is near its December 2021 level of 442,000, and the number of Fidelity IRA millionaires is near 373,000.
Fidelity has 21.5 million 401(k) participants. According to US Census data, there are about 52.6% as many IRAs as 401(k) accounts, so Fidelity likely has around 11.3 million of those. Thus, about 2.0% of 401(k) participants and 3.3% of IRA owners have over $1 million in their 401(k) and/or IRA, respectively.
Scaling from Fidelity’s 21.5 million 401(k) accounts to ICI’s estimate of 60 million 401(k) participants, there are about 1.2 million 401(k) millionaires in the US. Similar scaling gets us to about 1.0 million IRA millionaires.
Since it’s hard to know how many 401(k) millionaires are also IRA millionaires, we’ll neglect the overlap and estimate that up to 2.2 million Americans have at least $1 million in their 401(k) and/or IRA.
Using DQYDJ’s net worth percentile calculator, having over $1,512,350, places you in the 93.5th percentile (excluding primary residence equity) vs. the 90.5th percentile for $1 million.
With 123.6 million households in the US, about 68.4% of those with at least $1 million have more than $1,512,350. That’s about 1.5 million Americans with enough wealth that if it was all in IRAs, at least some of their money would be exposed to bankruptcy judgment.
The Bottom Line: Keep 401(k) Rollover Money Separate If You Could Exceed the Limit
Chances are that you aren’t yet a 401(k) and/or IRA millionaire.
From the above, we see there are only about 2.2 million of those fortunate and disciplined enough to have achieved that lofty goal. Increasing the threshold to the $1,512,350 BAPCPA exemption for IRAs reduces the count further to about 1.5 million Americans.
For those people who are unlikely to exceed the IRA exemption limit, Douglas Greenberg, President, Pacific Northwest Advisory says:
While it’s essential to be aware of the potential loss of unlimited exemption when merging 401(k) funds with an existing IRA containing non-rollover funds, this doesn’t mean one should always avoid it. Especially if you’re unlikely to exceed BAPCPA’s IRA exemption, you should weigh the simplified financial management and potential investment options against the risk of losing the exemption for some excess IRA money.
However, if you regularly invest as much as possible into your 401(k) account, you may ultimately join that wealthy group.
And then, don’t forget to avoid the one mistake when deciding what to do with your 401(k) account managed by your old employer.
You can (in most cases) leave the money where it is, (may be able to) roll it over into your new employer’s plan, or roll it over into a new IRA (or an established one as long as it only contains money from prior 401(k) rollovers).
In addition, if you’re a millionaire, consider buying an umbrella insurance policy. It’s an inexpensive way to protect your wealth if you get sued.
Find a Financial Advisor
What to Read Next:
Frequently Asked Questions
Is a 401(k) protected from lawsuits and bankruptcy?
Largely, yes. Under BAPCPA, assets in qualified plans such as 401(k)s, 403(b)s and government 457 plans are excluded from the bankruptcy estate. The article notes two exceptions: 401(k) money is not protected against tax liens or your spouse, and owner-only plans may be exposed to creditors outside bankruptcy.
Are IRAs protected from creditors the same way as 401(k)s?
Not entirely. Traditional and Roth IRAs funded with your own contributions are protected only up to a cap that was $1 million in 2005 and is adjusted for cost of living every three years. IRAs funded solely with money rolled over from employer plans keep the unlimited exemption.
How do I roll over a 401(k) without losing bankruptcy protection?
Roll it into a new IRA that holds only rollover money, or into an existing IRA that contains only money from prior 401(k) rollovers. Moving it into an IRA that already holds other contributions means the account is protected only up to the IRA cap. You can also leave the money in the old plan or move it to a new employer’s 401(k) if allowed.
Should I roll my old 401(k) into an IRA?
It depends. Advisors interviewed noted that an IRA can offer more investment choices and keeps the money in your name, while leaving it in a plan preserves loan privileges, avoids pro-rata issues with backdoor Roth conversions, and avoids triggering tax on an outstanding loan. Another advisor argued that consolidating into as few accounts as possible makes money easier to manage.
Does it matter if I combine 401(k) money with an existing IRA when I’m not wealthy?
Less so. One advisor interviewed said that if you’re unlikely to exceed the IRA exemption, you can weigh the simpler finances and investment options of combining accounts against the risk of losing protection on any excess. The article estimates only about 1.5 million Americans have enough wealth that some of it would be exposed if it were all in IRAs.
Find financial advisors who specialize in helping people like you
Search Wealthtender by specialty, location and fee type, compare advisors’ approaches, and read what their clients say before you reach out.
Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
At medium.com/@opher-ganel, you can read more of my articles and subscribe to receive email notifications when new ones come out.