A popular strategy for investors changing employers is a 403(b) or 401(k) rollover to an IRA. While it often makes sense to rollover a 401(k) when leaving a job, pay careful attention to ensure you are doing it the right way. Qualified retirement plans such as a 401(k) or 403(b) have better creditor protection than traditional IRAs. The wealth advisors at Darrow discuss best practices for preserving this protection during a 401(k) rollover.
Asset protection for retirement plan rollovers
The laws regarding federal bankruptcy protection for retirement assets are complex and subject to legal interpretation. To add to the complexity, not all retirement assets are covered the same way; and laws differ by state in relation to creditor claims other than bankruptcy.
If you have a 401(k) or 403(b) plan from a previous employer that you want to rollover to an IRA, it is important to first learn how your retirement assets will be protected once moved to an IRA. To help ensure your rollover assets are given the best creditor protection available, consider creating separate IRA accounts for rollover funds.
ERISA protection vs IRA protection
Assets in "ERISA-Qualified" retirement plans (like 401(k) and 403(b) plans) are excluded from an individual's bankruptcy estate without limitation.
As a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), both
traditional IRAs and Roth IRAs were given creditor protection in an aggregate value of $1 million, adjusted every three years for inflation. The last increase in 2016 was to $1,283,025.
It is important to note that this limit does not apply to rollover IRAs from a qualified plan. If done properly, rollover assets can maintain the unlimited creditor protection of the ERISA-Qualified plan it originated from.
Maintain separate rollover accounts
Although some interpretations of the laws differ, a conservative approach to rollover assets is advisable. By preserving the nature of these funds, you can easily distinguish between sources in the event of creditor claims.
Regardless of whether you have an existing traditional IRA or Roth IRA, open a new IRA for the rollover assets and label it as such for tracking purposes. Once the rollover is complete, refrain from making additional contributions to the rollover account.
Since the unlimited protection only applies to rollover assets, any additional post-rollover contributions would not qualify. Some interpretations of the law even suggest commingled assets could jeopardize the unlimited ERISA protection.
Opening a new IRA for rollover assets is the smart way to protect your retirement savings from creditors. Further, if you're working with a financial advisor, they will likely prepare the paperwork for you and guide you through the process.
Please be sure to consult your estate planning attorney for the most comprehensive guidance on your situation. Darrow Wealth Management does not provide tax and/or legal advice. Certain circumstances may require us to coordinate with your qualified tax and/or legal advisor.