Legal Protection for a 401(k) vs. IRA

Congress incorporated certain protections to owners of retirement accounts. Employer plans, including 401(k)s but not IRAs, fall under the provisions of the Employee Retirement Income Security Act, or ERISA, which generally put the plans beyond the legal reach of creditors, with a couple of exceptions. In contrast, IRAs receive only limited protection. One risk of rolling over a 401(k) into an IRA is the reduced protection from levies by creditors.

​Read More​: Are IRA Accounts ERISA Qualified?

A levy is a legal seizure of your property to satisfy a debt. In general, 401(k)s are protected from levies, with a couple of exceptions.

One way a 401(k) (and IRA) can be levied is through a qualified domestic relations order, or QDRO, issued by a state court. A judge can use a QDRO to award part or all of your retirement account money to a spouse, former spouse, child or other dependent. The person benefiting from the levy is the alternate payee.

Normally, a QDRO relates to a state’s laws regarding alimony, child support or marital property rights. The order must clearly identify the plan, the plan owner, the alternate payee and the amount to be levied.

​Read More​: Can You Pull From 401(k) Without Penalty to Settle Divorce?

The other way your retirement account can be legally attacked is if you owe money to the Internal Revenue Service. ERISA will not protect your 401(k) if you owe back taxes to the federal government. The IRS can levy almost all of your assets, including the money in your 401(k) and IRA. The amount levied is counted as a taxable withdrawal from your 401(k) or IRA account.

When the IRS grabs your retirement account money, it waives the ​10 percent​ early withdrawal penalty on money distributed before age ​59 1/2​. If you cash out your 401(k) or IRA to pay back taxes rather than allowing the IRS to levy the account, the money doesn’t qualify for the early withdrawal penalty exception on levies.

​Read More​: Acceptable Reasons to Cash Out a 401(k)

Unlike 401(k) accounts, IRAs are not covered by ERISA rules, making them more vulnerable to legal attack. As of 2021, the first ​$1,362,800​ of your IRA is not available to creditors if you declare bankruptcy. This protection comes from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and doesn’t apply to QDRO and IRS levies on your IRA.

If you don’t declare bankruptcy, the laws of your state define whether creditors can attack your IRA. The state courts have varying rules on the amount a creditor can collect if you choose not to enter into bankruptcy.

For example, California courts can determine how much money you need to support yourself and your dependents and award the rest to your creditors. In some states, Roth IRAs receive no protection.

Normally, you can roll over your 401(k) into an IRA when you retire or otherwise leave your job. Some employers allow you to maintain your 401(k) account even after you sever employment, thereby providing you with greater legal protection than that provided by a rollover to an IRA.

If you owe a federal tax liability, you must fill out Form 433-A so that the IRS can determine how you will satisfy your debt. IRS levies must follow guidelines that prevent you from becoming destitute and allow you to pay for out-of-pocket health care costs. Form 433-A allows you to record information about your personal assets, monthly income and expenses, and, if you are self-employed, your business assets, income and expenses.

You include QDRO payments in your monthly expenses, which means that a QDRO levy trumps an IRS levy. You must disclose information about your 401(k) and IRAs in the investments section of Form 433-A.