Can Creditors Take Retirement Accounts

Emily just received a devastating blow. Her husband, Roy, passed away unexpectedly, leaving behind a mountain of credit card debt and a seemingly airtight estate plan – including a valid will and a properly funded revocable trust. But a recent notice from a major credit card company threatens to sue the trust, claiming Roy’s IRA is a reachable asset. Emily is panicked. She believed retirement accounts were untouchable, and now faces potentially losing a significant portion of her future security. The cost of defending this claim, even if successful, could easily reach $10,000 – money she desperately needs to support her family.

As an estate planning attorney and CPA with over 35 years of experience, I see this scenario far too often. While the general rule is that federal law strongly protects retirement accounts from creditors, the reality is much more nuanced. It’s not a simple “yes” or “no” answer, and failing to understand the specific protections – and the exceptions – can lead to devastating consequences for your heirs. My CPA background is particularly valuable here; understanding the step-up in basis and potential capital gains implications of forced distributions during probate is crucial to minimizing tax exposure.

What Federal Laws Protect Retirement Accounts?

The Employee Retirement Income Security Act of 1974 (ERISA) is the primary federal law safeguarding most qualified retirement plans, such as 401(k)s, 403(b)s, and traditional IRAs. These plans are generally shielded from attachment by creditors – both during life and after death. This protection is robust, but it’s not absolute. There are several key exceptions.

When Can Creditors Reach Retirement Funds?

There are specific situations where creditors can access retirement assets. These generally fall into a few categories. First, bankruptcy is a significant exception. While it’s difficult, certain bankruptcy proceedings can allow a trustee to liquidate retirement accounts. Second, court-ordered domestic relations orders (DROs) stemming from divorce or separation frequently allow for the division of retirement assets. This is a common and legally sound way to access funds.

However, the most frequent challenges I see arise from federal tax liabilities. The IRS has a unique power to levy retirement accounts to satisfy unpaid taxes. Similarly, unpaid federal student loans can also trigger a levy. These government claims often take precedence over other debts.

What About Creditors After Death – in Probate?

This is where things get particularly complicated. While ERISA continues to offer protection to the beneficiary of the account, the rules shift significantly within a probate proceeding. Generally, assets owned by the estate are subject to creditor claims. The crucial question becomes: how is the retirement account owned?

• Payable-on-Death (POD) or Transfer-on-Death (TOD) Designations: These designations pass the account directly to the beneficiary, outside of probate. This is the strongest protection. The funds are generally shielded from estate creditors.
• Accounts Owned by the Estate: If the retirement account is listed as an asset owned by the estate in the will or trust, it becomes subject to creditor claims just like any other estate asset.
• Revocable Living Trusts: Accounts held within a properly funded revocable living trust are generally protected, but creditors may attempt to “claw back” assets if the trust was used for fraudulent purposes or to avoid legitimate debts.

How Long Do Creditors Have to Make a Claim?

Creditors don’t have unlimited time to pursue assets in probate. Probate Code § 9100 dictates that creditors have a strict window to file a claim: either 4 months after Letters are issued or 60 days after notice is mailed (whichever is later). Once this period expires, unfiled claims are generally forever barred, protecting the heirs. However, it’s crucial to remember that certain creditors, like the government (IRS, Medi-Cal), have extended timelines. Probate Code § 9202 states that the executor has a mandatory duty to send specific notice to the Franchise Tax Board, Victim Compensation Board, and Medi-Cal (DHCS) within 90 days of appointment. Failure to notify these agencies pauses their statute of limitations, allowing them to claw back assets years later.

What Happens if a Creditor Disagrees with the Executor?

If an executor rejects a creditor’s claim (using Form DE-174), the creditor has exactly 90 days to file a lawsuit in civil court, per Probate Code § 9353. If they fail to sue within this window, the claim is legally dead. However, litigating these disputes can be expensive, and the executor must be prepared to defend the estate’s position vigorously. Furthermore, executors who pay low-priority debts first can be personally liable, as outlined in Probate Code § 11420. Debts aren’t paid first-come, first-served.

What About Interest on Outstanding Debts?

It’s vital to remember that debts bear interest from the date of death (or the date the claim is allowed) at the rate of 10% per annum (unless the contract specifies otherwise), according to Probate Code § 11423. Delaying payment unnecessarily drains the inheritance, and this interest can quickly add up.

What if Assets Were Transferred to a Trust?

While probate requires creditor notice, trusts do not automatically trigger this process. However, a trustee can opt-in to the claims procedure to cut off liability after 4 months, as detailed in the Optional Trust Claims Procedure (Probate Code § 19000). Without this, creditors can theoretically sue the trust beneficiaries for up to 1 year after death (CCP § 366.2).

What determines whether a California probate estate closes smoothly or turns into litigation?

The path through California probate is rarely a straight line; it requires precise adherence to statutory deadlines, accurate asset characterization, and strict fiduciary compliance. Without a clear roadmap, what begins as a standard administrative proceeding can quickly dissolve into a costly battle over interpretation, valuation, and beneficiary rights.

A stable probate administration outcome usually follows from clarity, consistency, and readiness for court review, especially when multiple stakeholders and competing interpretations are involved. When documentation supports enforcement and timelines are respected, families are less likely to face preventable escalation.

Verified Authority on Probate Creditor Claims

• The Creditor Window (4-Month Rule): California Probate Code § 9100
  This statute provides the primary protection for the estate. Generally, any creditor who fails to file a formal claim within four months of the executor receiving Letters is barred from collecting. This “clean break” is one of the main advantages of formal probate.
• Mandatory Notice to Public Agencies: California Probate Code § 9202
  Regular creditors aren’t the only concern. You MUST send specific notices to the Director of Health Care Services (Medi-Cal), the Franchise Tax Board, and the Victim Compensation Board. Missing this step keeps the liability window open indefinitely for the state.
• Priority of Payments: California Probate Code § 11420 (Debt Hierarchy)
  If an estate is “insolvent” (debts exceed assets), you cannot simply pay bills as they arrive. This code establishes the strict pecking order: funeral expenses and administration costs (lawyer/executor fees) get paid before credit cards and medical bills.
• Rejection of Claim (The “Sue or Lose It” Rule): California Probate Code § 9353
  When an executor formally rejects a claim (Form DE-174), the clock starts ticking. The creditor has exactly 90 days to file a civil lawsuit to enforce the debt. If they miss this deadline, the claim is barred, regardless of its validity.
• Personal Liability of Executor: California Probate Code § 9601
  An executor can be held personally liable for “breach of fiduciary duty” if they pay debts out of order (e.g., paying a credit card before the funeral home) or distribute assets to heirs before clearing all valid creditor claims.
• One-Year Statute of Limitations (Non-Probate): California Code of Civil Procedure § 366.2
  This is the ultimate backstop. Even if no probate is opened, creditors generally only have one year from the date of death to file a lawsuit against the decedent’s successors (e.g., trust beneficiaries). After one year, most debts expire automatically.