Don’t pledge your IRA as collateral or you might lose creditor protection

Retirement accounts that qualify under the Employee Retirement Income Security Act (ERISA) are generally protected from creditors, bankruptcy proceedings and civil lawsuits. Ordinarily, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 extends similar federal protection to IRAs up to $1 million (though money rolled over from an ERISA-qualified plan into an individual account may not be subject to these limits). An individual retirement account, commonly called an IRA, is defined in the Internal Revenue Code as a “trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries.” 26 U.S.C.A. § 408(a). Funds in an IRA are presumed to be exempt from the bankruptcy estate if the funds have “received a favorable determination” from the Internal Revenue Service. In re Daley, 717 F.3d 506, 508 (6th Cir. 2013)

HOWEVER, if you pledge your retirement account as collarteral on a loan, you can lose your protection. That is what happened in Kearney Constr. Co., LLC v. Travelers Cas. & Sur. Co. of Am., 795 Fed. Appx. 671 (11th Cir. 2019). There, Bing Kearney borrowed money and gave the following pledge in a security agreement:

Grant of Security Interest. As security for any and all Indebtedness (as defined below), the Pledgor hereby irrevocably and unconditionally grants a security interest in the collateral described in the following properties[:] all assets and rights of the Pledgor, wherever located, whether now owned or hereafter acquired or arising, and all proceeds and products thereof, all goods (including inventory, equipment and any accessories thereto), instruments (including promissory notes)[,] documents, accounts, chattel paper, deposit accounts, letters of credit, rights, securities and all other investment property, supporting obligation[s], any contract or contract rights or rights to the payment of money, insurance claims, and proceeds, and general intangibles (the “Collateral”).

The Eleventh Circuit found this pledge included Kearney’s IRA. For that reason, the IRA was at-risk to re-pay Kearney’s loan.

With respect to ERISA plans, the anti-alienation cause in federal law protects accounts with four exceptions: Payments awarded to a former spouse or other alternate payee under a qualified domestic relations order; a lien imposed by the IRS for nonpayment of taxes; Federal criminal fines or  penalties; and civil or criminal judgments for damage a participant caused to a retirement plan. The types of plans protected include: 401(a) profit-sharing, 401(k), 403(b), nongovernmental 457, defined benefit, and SIMPLE 401(k) plans, as well as SIMPLE and SEP IRAs.