When considering whether to sponsor a qualified retirement plan, such as a 401(k), or a Simplified Employee Pension plan ("SEP IRA"), one consideration is the protection offered to amounts held in the plan from creditors, civil litigation, and bankruptcy. While the law in this area is constantly evolving, both in terms of case law and Congressional action, currently, there are some differences in the level of protection offered to such amounts, as discussed below.

Qualified Plans

In general, the assets held in an account under a qualified retirement plan are protected by the Employee Retirement Income Security Act of 1974 ("ERISA") and the Internal Revenue Code ("Code"). Section 206(d) of ERISA contains an anti-alienation provision, which requires each retirement plan to provide that the benefits provided under the plan may not be assigned or alienated. A similar provision is found in section 401(a)(13) of the Internal Revenue Code, and the two provisions generally protect tax-qualified retirement plan accounts from the claims of creditors of plan participants and their beneficiaries. There are a few limited exceptions from this protection for (i) the division of retirement benefits in a divorce, (ii) federal tax levies and (iii) fiduciary violations or crimes by a plan participant against the plan.

Aside from these exceptions, however, funds held in a participant's account under a qualified retirement plan are generally protected from creditors.  Specifically, assets held in a qualified plan account would be excluded from an individual's bankruptcy estate (and therefore not subject to attachment by creditors), would not be subject to a civil judgment award against a participant, and should not be available to a participant's general creditors. Note, however, that there is an argument that the protections offered to tax-qualified retirement plan accounts may not apply to qualified plans in which only business owners participate.


In contrast to qualified retirement plans, the anti-alienation protections offered under ERISA and the Code detailed above do not apply to assets held in a SEP IRA. However, certain protections are available in some cases, by other federal and state laws.

Bankruptcy: The federal Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") excludes assets held in a SEP IRAs from bankruptcy, with no limitation on amount. In general, this means that retirement assets held in a SEP IRA would not be factored into the amount available to pay bankruptcy creditors. However, note that non-SEP individual retirement accounts are protected only up to $1,000,000 (adjusted for inflation), and it is possible that, if an employee terminates employment with an employer who offers a SEP IRA, but leaves an account in that plan, his or her account may be viewed as a non-SEP individual retirement account and be subject to the more limited protection.

In addition, some practitioners have raised questions regarding whether BAPCPA protects retirement plans such as SEPs once assets are allocated from the SEP arrangement (the plan) to individual SEP IRA accounts, arguing that such individual accounts are not subject to ERISA's anti-alienation provisions and therefore would not be excluded from a bankruptcy estate.  Accordingly, although it seems likely that BAPCPA would exclude assets held in a SEP IRA from bankruptcy, there is some uncertainty that they would in fact be protected under federal law. Keep in mind, though, that some state laws might offer bankruptcy protection to such assets and the application of these statutes likely would not be preempted by ERISA.

An additional caveat here is to check whether the IRA agreement in place for the SEP IRA has a "cross-collateralization agreement."  This is a default provision found in some IRA agreements that would allow a loan owed in any other accounts maintained with the same recordkeeper to be covered by assets held in the IRA; in essence, these agreements pledge the IRA assets as collateral for a potential loan outside the IRA. This is technically a prohibited transaction under section 4975 of the Code, and would permit the bankruptcy shield under the Bankruptcy Code to be pierced, meaning that retirement funds could be accessed by bankruptcy creditors. A recent decision by the Sixth Circuit found that the mere existence of a "cross-collateralization agreement" wouldn't disqualify the IRA from exempt status in and of itself, but the actual use of such an agreement could. Accordingly, some practitioners are suggesting removing cross-collateralization provisions altogether from an IRA agreement in order to avoid a possible issue.

Other Creditors: Generally, a SEP IRA would not be protected from the claims of other creditors or civil litigation judgments, unless protected by state laws. Protections for individual retirement accounts vary from state to state, and the applicable state law depends upon the state in which the account owner resides. Also, if an individual is in bankruptcy, some attorneys believe the trustee could elect to take a distribution and circumvent state law.

In summary, qualified retirement plans and SEP IRAs enjoy many of the same protections in bankruptcy and from creditors.  However, the protections offered to qualified retirement plans are more robust, and there are fewer open questions with respect to how the protections should be applied. Accordingly, many employers choose to use a qualified retirement plan to gain maximum protection for account assets from bankruptcy and the demands of other creditors. That being said, some employers are comfortable with the protections arguably offered by a SEP IRA in light of the ease of administration.

For further information visit Waller's ERISA Exchange blog

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.