Do IRAs have less liability protection than 401Ks?

[Markola]

I would like to ask for some clarification about the liability protections of 401Ks (and their brethren like 403Bs) versus IRAs. Some opinions I've read, like this thread from 2007, seem to indicate that all is well because IRAs now have full federal protection up to $1M:

http://www.early-retirement.org/forums/f28/401ks-and-iras-and-lawsuits-29252.html

That's great except that we have north of that amount in our IRAs, as do lots of others here. Other links I've read on the interwebs indicate that, no, IRAs remain less protected than 401Ks from bankruptcy creditors (and I assume other legal claimants?) because they are subject to the laws of one's state of residence. See:

http://www.thetaxadviser.com/content/dam/tta/issues/2014/jan/stateirachart.pdf



We have $2 million in a liability policy but if there's a big legal vulnerability in IRAs, then that is rather important to know about. I don't trust insurance companies all that much either. Maybe I will roll our IRAs back into our 401Ks to sleep more soundly in our litigious society. Any insights are much appreciated.

 

[pb4uski]

I have a similar sized umbrella. The way I figure the insurer has millions of reasons to make sure a plaintiff does not prevail against me. Never been sued and don't expect to be. Liability protection of my tIRA is so far down the list of things I worry about that I can't even see it. Relax.

 

[Sunset]

I figure umbrella insurance is there to make the insurance company fight for you.
While your insurance company fights for years to deny liability, you can spend down the IRA's

You have to consider, most 401K's charge large fees sometimes hidden, and limit choices to expense funds.
A 2% extra charge on a $1 million account is $20,000 per year, that is a pretty expensive payment to try to be a bit safer.

How about splitting the IRA's and everything else into individual names, surely they are that way right now, so even if say you were driving a car and ran over a group of children, your spouse's accounts are not even part of the suit as he/she was not the driver.
Right away that limits what is vulnerable in a lawsuit.

 

[kaneohe]

Can Judgment Creditors Go After My Retirement Accounts? | Nolo.com

My impression is that ERISA plans like 401Ks have stronger protection esp.
in a few states like CA which have weak IRA protections . If your 401K plan is not horrible and you can live w/ the possibly more restrictive distribution rules,
there may be some benefit to staying w/ the 401K.

The greater IRA protection in recent years comes from the bankruptcy law so
you may have to file successfully for bankruptcy to get that protection. The
401K protection comes from ERISA so you do not need to be in bankruptcy protection.

The belt and suspenders of umbrella liability insurance and 401K protection is comforting.

 

[Senator]

In my opinion, if you are ever making the decision to rollover your 401K or not based upon liability protection, you have probably lived a life that provided others the will to take it.

Live life in a decent manner, and there is no need for liability protection between a 401K and an IRA. I roll my 401K over and I also carry business and personal umbrella policies.

 

[Corporateburnout]

I recently rolled over my 401K into an IRA primarily because my former employer changed the investment options I was in and I did not like the new options with no ticker symbols such as investment trusts.

The 401K provides better federal liability protection but most states provides liability protection for rollover IRAs. My state provides full protection for rollovers. I was also advised not to commingle the rollover account with other IRA assets and to have a separate brokerage account to hold any distribution from the rollover IRA for better traceability.

 

[Dash man]

I'll be rolling my 401k into my Roth IRA and tIRA accounts after the first of the year. I have a large after tax contribution I need to move into the Roth IRA before they change their minds again. I bumped up my umbrella coverage and my homeowners and automobile liability, so I think the insurance company lawyers will put up a pretty good fight and not give up $6M easily, before they get into my investments. DW plans on keeping her money in the 401k just in case.


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[kaneohe]

Here's an analysis by Alan S. of the fairmark.com site:

Re: IRA vs 401(k)
Posted by: Alan S., October 10, 2007 09:35PM
Generally, you are better served to directly transfer the former employer plans to a traditional IRA account. You have a wide choice of IRA custodians and almost an unlimited choice of investments. The IRA will usually have broader beneficiary options, and you can convert some or all of it to a Roth IRA if you qualify. The following is a list of some specialized reasons why the IRA transfer may not be best:

1) You live in a state that does not protect IRAs from creditors, and you have credit problems or are prone to litigation. Perhaps you do not carry adequate insurance limits. In these cases, an employer plan provides broader protection under ERISA with no dollar limit.

2) You understand your old plan and know it is invested properly, but will not be able to allocate the investments properly in the IRA. Perhaps you have info paralysis and just let it sit in a MM fund for lack of time to do the research or get help. On the other extreme, you start day trading in the IRA and lose principal. In those cases, you would be better off without the IRA.

3) You are in the age 50-55 range. In this situation, when you reach 55 and separate from your current employer, you receive an exception from the early withdrawal penalty. With the IRA, you must wait until 59.5 or start a rigid 72t program to avoid the penalty. If you transfer to the new plan, the transferred funds will qualify for the penalty exception at 55 if you separate then or later.

4) You are aware of the dangers of 401k loans, but still feel you need that option. In that case, the old plan should go to the new plan, so you will have the dollars for a 401k loan. No loans are available from an IRA, only 60 days of use and then the funds must be rolled back to avoid a taxable distribution.

5) If you have highly appreciated employer stock in your old 401k, you have the potential for NUA (net unrealized appreciation), where the gains are taxed at the lower LT cap gain rate when you sell the shares. If these shares are transferred to an IRA or another plan, this opportunity is lost. Don't do anything until you check on the cost basis of any highly appreciated employer shares. For NUA to be compelling that cost basis should be less than 1/3 of their current value.

If none of the above 5 situations apply to you, you are better off to transfer to the IRA. If one or more does apply, you may still be better off, but should carefully weigh the options.

Fairmark Forum :: Retirement Savings and Benefits :: IRA vs 401(k)

 

[pb4uski]

^^^^^ Good advice

While he would not have known this in 2007, in this low interest rate environment with the likelihood of higher interest rates, I would add that if you have access to a stable value fund that pays near the 10 year treasury in your 401k then that is a benefit worth retaining, at least in part, since you can't get a stable value fund outside of a 401k.

Also, on #3, I would modify it to keep it in the 401k if you might need to use that money between 55 and 59 1/2.

 

[daylatedollarshort]

We're not rolling over our ERISA 401Ks. They have fairly bullet proof, cheap asset protection, decent investment choices plus stable value funds. We also have business insurance and an umbrella personal policy, and the businesses divided up and set up as LLCs. We took our pensions as annuities instead of putting all the money in a lump sum IRA. We keep a mortgage and line of credit open on the house.

I wouldn't want to risk losing what took decades to build up in one car accident, so we have as many simple and inexpensive asset protection layers as we can think of for our state.

 

[pb4uski]

Stable value funds would be enough to tip the scales for me.

And while I don't see potential litigation as a significant risk if I lived where you do I might think differently.

 

[Markola]

Thanks for this good discussion. It seems from others here that there is some indeed some credibility to the risk. Though DW is a Federal employee and we have brand-name Aetna health insurance through them, we are currently battling Aetna to pay for an expensive chemo drug that DW's doctor has prescribed. I think it will work out, and I don't truly fear medical bankruptcy, but it proves how one can draw poor cards in life so taking extra measures to make oneself as financially bullet proof as possible has value. She has accumulated about a third of our savings so I'm leaning toward asking her to roll her IRA into the Federal TSP plan. The fund expenses are not awful at around .28 and the choices pretty straightforward. Also, as noted by others here, those funds should be marginally easier to tap past age 55 if she leaves service and we need to. I think that's a good deal for some extra protection and flexibility. My own organization's 403b is a high fee dinosaur of a company, Mass Mutual, where the least expensive fund is an S&P 500 Index with close to a .50 ER and goodness only knows what other hidden fees. Until I have better choices at my work, I'll leave my IRA, both of our Roths and our taxable account at Vanguard, which comprises 2/3 of what we have.


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[daylatedollarshort]

She has accumulated about a third of our savings so I'm leaning toward asking her to roll her IRA into the Federal TSP plan... Also, as noted by others here, those funds should be marginally easier to tap past age 55 if she leaves service and we need to.

We rolled some of DH's IRAs into his last employer's 401K plan before he retired so we could access the extra money penalty free in case we needed it from ages 55 - 59.5.

 

[Turn_the_Page]

Never thought about it. Of course, the next question is "which states shield the IRA from creditors?"

Looks like Texas does. I didn't check the other 49

 

[ziggy29]

Never thought about it. Of course, the next question is "which states shield the IRA from creditors?"

Looks like Texas does. I didn't check the other 49

Texas, Florida and Oklahoma have the strongest asset protection laws with respect to retirement accounts.

The distinction between treatment in asset protection is that 401K and 403B plans and the like are considered pension plans which are fully protected by federal law, and IRAs are not.