View Biography Thomas M. Hughes

One of the questions that arises occasionally with our clients is whether it is better for a business to offer its employees a retirement benefit through a 401(k) Plan (“Plan”) or a Simplified Employee Pension (“SEP”). (A SEP is a vehicle for an employer to contribute to its employees' individual IRAs). Of particular interest in analyzing this question is whether a profit sharing plan or a SEP puts the Plan participants at greater risk to creditors of the company or to the participant's own creditors should either become a judgment creditor.

There are two certainties in this area. The first is that the funds which are deposited into the company's Plan are not available to creditors of the company. These funds are held in a separate trust under ERISA and a creditor of the company cannot claim any money from that Trust in order to satisfy a claim against the company.

The second certainty is what will happen if one of the Plan participants subsequently has a judgment entered against that participant. The answer to this question is that the funds allocated to an individual account within the Plan cannot be seized by a creditor (other than the IRS or a spouse in a family law proceeding) under ERISA. Creditors of employees with accounts in ERISA plans have attempted to seize funds allocated to a participant's account out of a Plan. However, there are a number of judicial decisions which have held that the creditor has no right to seize those funds from the Plan until after they are paid to the participant.

While a creditor can wait and attempt to seize those funds once they have been withdrawn from the Plan, the creditor cannot force either the Plan or the Trust to compel a distribution under ERISA. As a result, those funds are only subject to attachment by a creditor once they have been distributed to the Participant and are held outside of the Trust.

Our experience in this area is that creditors generally are not interested in waiting to collect the debt until a participant elects to make a withdrawal. Usually, this means that the creditor negotiates with the participant.

However, an individual IRA account that is held by a participant with money from a company SEP is subject to attachment by his creditors. The only protection that is provided for an individual IRA/SEP account is provided by state law. There is no non-bankruptcy federal law protecting the IRA from judgment creditors.

At the present time, the starting amount under Minnesota law that can be protected from creditors in an IRA is $57,000 per individual. This amount is adjusted periodically.

A participant can assert that a greater amount should be protected due to the participant's circumstances, but that would have to be determined by a court. If a participant has an IRA account worth $300,000, what this means is that all of the dollar value in that IRA in excess of $57,000 may, unless the participant convinces a court to order otherwise, be seized by a creditor of that participant.

An additional protection for an IRA from creditors was added under the recent amendments to the federal bankruptcy statute. Under those amendments, it is likely that a participant's IRA account may be protected in a bankruptcy proceeding for up to $1 million dollars. However, this protection will not be available unless the participant actually files for bankruptcy. If a bankruptcy filing does not occur, the maximum amount that can be protected if a participant has a judgment entered against him or her is presently the general $57,000 exemption under Minnesota law.

If you have any questions, contact Thomas M. Hughes of our Minneapolis Office.