Is it important to factor in safety from creditors during a 401k rollover? How safe was the money in the 401k and how safe will it be in an IRA? How important is it to consider this as a financial advisor?
What’s protected in a 401k?
As most advisors know, a 401k account is generally far from creditors’ reach. ERISA protects funds in a 401k through an anti-alienation provision.
This means that most any creditor will be unable to touch money that’s in a 401k account. It has some of the highest level of protections against creditors.
What’s protected in an IRA?
However, when these funds are rolled over into an IRA, they might lose some of their protections under the ERISA provision. In the case of bankruptcy, these funds can remain under the same ERISA protection.
In fact, because of Section 224 of the Bankruptcy Abuse Prevention and Consumer Protection Act, all traditional and Roth IRA’s are guaranteed protection for up to a certain amount in the event of bankruptcy.
As of the April 1, 2016 adjustment date, that number is currently $1,283,025 in protected assets; If, however, an investor is not filing for bankruptcy, the IRA could be at risk to creditors. The exact way that protection is determined is different in each individual state.
Does this affect the advisor?
So why is it important to consider protections when proposing a rollover?
Because many advisors are now fiduciaries (as of DOL June 9 rule), those affected need to determine investor suitability.
If they’re an investor with debt or in a position that predisposes them to debt, that affects their rollover suitability. Each investor’s situation needs to be evaluated on an individual level.
Does the client have outstanding loans in their current 401k account? Are they likely to need additional loans? Is it likely that this investor will need protection from creditors in the present or future? Would they benefit from remaining in their original ERISA protected 401k? What are your specific state’s laws that govern IRA’s and creditor protection?
Considering the investor’s financial situation is crucial to being an ERISA fiduciary. Financial advisors must have a complete understanding of the client’s circumstance. As an advisor and a fiduciary, recommending that the investor rolls to an IRA, even though they had questionable suitability, means possible risk or private legal action.
What can I do?
As a financial advisor, what is your best course of action? In a worst-case scenario, how can you prove that you were acting in the client’s best interest? How can you prove that you assessed their situation and determined that a rollover was prudent? How can this thought process be easily documented?
You need to consider all factors and most importantly the rollover services you offer. It is not just a number of different service line items, but their importance and whether the investor can obtain them without moving the assets to you.
You can recommend a rollover if services you offer cannot be obtained in a current plan and/or if the plan itself does not allow for a high-quality portfolio with reasonable expense.
In case of creditor protection in ERISA plans, if client’s debt situation clearly suggests such protection may be important to them, it’s best to not move the money outside of the plan’s safe haven.
Luke St. Angelo is with RiXtrema, a research and fiduciary software company. RiXtrema’s IRAFiduciaryOptimizer gives advisors a much-needed platform to conveniently document suitability and prove that an advisor was acting in the investor’s best interest. Our Individual Factors section in the IRAFiduciaryOptimizer’s rollover wizard allows you to quickly and seamlessly document your thought process and reasoning around the client’s financial situation and their predisposition to loans or need of credit protection.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
