Retirement accounts at ‘serious risk’ as COVID-19 spurs bankruptcies
The coronavirus pandemic has disrupted many things around the world, let it be the workplace, schools, everyday life habits, and it has even disrupted retirement accounts. In the nine months of COVID-19 hitting businesses, bankruptcies and lawsuits have risen and caused many questions. Read this blog post to learn more.
If there’s one thing clients have always relied on in troubled times, it’s that last bastion of savings, the retirement account — whether it be a 401(k) or an IRA.
But we’re now into the ninth month since COVID-19 hit our shores and nothing can be taken for granted. Business closures, bankruptcies and lawsuits from creditors have soared, calling into question even that formerly unassailable bulwark. That’s why it’s crucial that advisors know which accounts can be protected in bankruptcy and in non-bankruptcy lawsuits — and which cannot.
Make no mistake: Not all possess the same safeguards. Retirement accounts carry a number of different protections. These layers of defense shield IRA owners and company plan participants from bankruptcy and general (non-bankruptcy) creditors. In addition, levels of protection vary widely from state to state. In the current environment with so many small businesses on the brink of closing and struggling employees in limbo, increased bankruptcy filings are placing retirement savings at serious risk, especially when these might be the only funds available for a personal bailout.
That’s why it is imperative to understand which accounts hold what protections, and how retirement assets are shielded from those anxious to get a piece of their nest egg.
ERISA plans: The gold standard
Most employer-sponsored retirement plans, such as 401(k)s, fall under the Employee Retirement Income Security Act of 1974 guidelines and receive creditor protection at the federal level. ERISA offers the gold standard of protection up to an unlimited amount against both bankruptcy and non-bankruptcy general creditor claims.
To illustrate, let’s take the hypothetical example of “Mark,” a successful contractor who flips houses. He has a 401(k) plan set up for himself and the employees of his sole proprietorship. Mark’s current plan balance is $1,500,000.
Recently, however, there was an accident at one of his construction sites, and Mark is being sued personally. Even if Mark loses the lawsuit, the assets in his 401(k) remain protected by ERISA up to an unlimited amount. Additionally, if Mark were to declare bankruptcy, his 401(k) would be off limits to bankruptcy creditors.
Going solo = greater exposure
The same protections do not, however, hold for solo 401(k) plans.
Often, business owners worried about potential lawsuits keep their retirement funds in their so-called solo-K because they believe it to be fully creditor proof, as opposed to an IRA.
Butsolo 401(k) plans are not covered by ERISAand have no creditor (non-bankruptcy) protection under that law. Plan balances will only receive non-bankruptcy creditor protection available under applicable state law.
These plans do, however, receive full bankruptcy protection under the bankruptcy code. This is also the case with other non-ERISA company plans such as SEP and SIMPLE IRAs, non-ERISA 403(b) plans and 457(b) governmental plans.
Bankruptcy and IRAs
Traditional and Roth IRA contributions and earnings are protected from bankruptcy under federal law up to an inflation-adjusted cap — currently $1,362,800.
Is this a sufficient limit?
If the maximum amount was contributed to an IRA each year from 1975 to 2020, there would be $141,500 in contributions — $158,500 if the IRA owner qualified for age 50 catch-up contributions available beginning in 2002. It is unlikely that the earnings, even for those who contributed the maximum each year, would push an IRA balance over $1,362,800.
But what about rollovers from plans to IRAs? Do these dollars count against the $1,362,800 cap?
They do not. Former company plan assets (previously protected by ERISA while in the plan) rolled to an IRA will obtain unlimited bankruptcy protection under the bankruptcy code. As an added bonus, rollovers from SEP and SIMPLE plans also do not count against the $1,362,800 cap.
As an example, let’s conjure up “Sheila,” an attorney with a $2,000,000 balance in her company’s ERISA 401(k) plan and a $700,000 balance in her IRA, which is composed entirely of contributions and earnings.
In April, Sheila retired from her law firm and in May rolled her 401(k) into her IRA. Sheila’s IRA is completely shielded from bankruptcy. The bankruptcy code protects her $2 million 401(k) rollover up to an unlimited amount, and the $1,362,800 cap is enough to cover her original IRA balance.
Note that in this example, Sheila did not need to keep her 401(k) and IRA dollars separate to retain the maximum bankruptcy protections. However, from an administrative standpoint, it could make sense for some individuals to keep rollover assets separate via a conduit IRA to avoid confusion.
Lawsuits and IRAs (non-bankruptcy)
General creditor protection (e.g., when a person wins a judgment in court against the account owner) for IRAs, Roth IRAs and IRA-based company plans like SEPs and SIMPLEs is based on individual state law — and these state-level, non-bankruptcy protections vary widely.
As such, it is important to understand your client’s state coverage, especially before advising the client to roll over ERISA plan dollars into an IRA.
As mentioned, ERISA-covered plans enjoy full bankruptcy and general creditor protection. While all former plan dollars remain protected in bankruptcy by the bankruptcy code after a rollover to an IRA, these same dollars do not retain unlimited general creditor (non-bankruptcy) protection. Assets rolled from an ERISA plan to an IRA will now fall under the applicable state-level protections. These state safeguards may be comparable to ERISA levels, or they may be significantly less so.
For instance, the hypothetical“Dr. Kapp” changed employers and is deciding what to do with his $400,000 401(k) plan. His profession exposes him to malpractice lawsuits. If Dr. Kapp rolls the assets from his work plan to an IRA, the $400,000 will be fully protected in bankruptcy. However, he will be limited to the general creditor (non-bankruptcy) protections offered under state law.
Instead, Dr. Kapp elects to roll his former plan assets into the 401(k) plan offered by his new employer. That way, he ensures the $400,000 will retain 100% ERISA protection from both bankruptcy claims and any malpractice judgments against him.
Inherited IRAs and bankruptcy
In a landmark decision released in 2014,Clark v. Rameker, the U.S. Supreme Courtruled unanimously that inherited IRAs are not protected in bankruptcy under federal law.
Since only "retirement funds" are protected under the bankruptcy code, the primary issue before the court was whether an inherited IRA is, in fact, a retirement account. The Supreme Court decided that inherited IRAs do not contain “retirement funds” because:
1. Beneficiaries cannot add money to inherited IRAs;
2. Beneficiaries of inherited IRAs must generally begin to take RMDs, regardless of how far away they are from retirement; and
3. Beneficiaries can take total distributions of their inherited accounts at any time and use the funds for any purpose without a 10% early distribution penalty.
As a result, the favorable bankruptcy protection afforded to such funds under the bankruptcy code does not extend to inherited RIAs.
Bankruptcy timing and rollovers in transit
IRAs and retirement accounts protected under the bankruptcy law are generally shielded only as long as the funds remain qualified. Creditors will sit patiently until retirement dollars are withdrawn to snatch them as unprotected assets.
IRAs and the LLC shield
IRAs enjoy specific levels of protection against “outside” claims, i.e., claims brought personally against the IRA owner.
But what happens when a claim is brought against an investment within the IRA? The answer is that such “inside” claims may not only devastate the IRA but could also put an IRA owner’s personal non-qualified assets at risk. Inside claims can be mitigated with the use of a limited liability company (LLC).
The imaginary “Blake” owns a self-directed IRA worth $500,000 that invests entirely in a local Jet Ski rental and watersports company. He did not use an LLC within the IRA to acquire the rental business. Blake has other personal assets worth $1.5 million.
Last summer, a Jet Ski renter had an accident and suffered a catastrophic injury. After almost a year of litigation, the renter won a $2 million judgment against the IRA.
All of Blake’s IRA assets could be reached because the claim arose from activities of the IRA investment. His personal assets could also be at risk. But if Blake’s IRA had been invested in an LLC that subsequently purchased the water sports company within the IRA, the LLC structure would have protected both the IRA assets and Blake’s personal assets against the $2 million judgment.
Be keenly aware of outside vs. inside claims and how to mitigate certain risks with an LLC.
Clear and present danger
Add the ongoing COVID-19 outbreak to our litigious society with the increasingly looming possibility of bankruptcies, all under the watchful eye of SEC Reg BI, and educating clients on available safeguards becomes increasingly vital.
That education holds even more true for financial advisors in whom clients have placed their trust and financial futures. Understanding the levels of bankruptcy and non-bankruptcy protections afforded to both workplace retirement plans and IRAs is now a must to safeguard the dreams of post-work life clients have worked so hard to achieve.
SOURCE: Slott, E. (10 September 2020) "Retirement accounts at ‘serious risk’ as COVID-19 spurs bankruptcies" (Web Blog Post). Retrieved from https://www.financial-planning.com/news/retirement-accounts-at-risk-as-coronavirus-spurs-bankruptcies
IRA spousal contributions can mitigate the high cost of women’s work breaks in retirement plans
According to a November 2018 study, women who took a year off from work in a 15-year period had 39 percent lower average annual earnings than women who worked continuously through that time. Read this blog post for more on how spousal contributions can mitigate the high cost of work breaks in retirement plans.
Women employees face special retirement savings challenges compared with their male counterparts. On average, they earn less and log fewer years of earned income compared to men. That’s because, in part, because women take multiple breaks from work, turn down work or decline promotions because of family care obligations.
The cost of a career break can be high. A November 2018 study by the Washington-based Institute for Women’s Policy Research found that women who took just one year off from work in a 15-year period had 39% lower average annual earnings than women who worked continuously through that time. The study also showed that the number of women taking at least one year off of work during a 15-year period was nearly twice the rate of men — 43% of women compared to 23% of men.
As a result, women are less likely to set aside money in a savings arrangement or to contribute to an employer-sponsored retirement plan.
Spousal advantage
Married women (and men) who take work breaks may stay on track with their retirement savings goals by making IRA (traditional or Roth) contributions based on their working spouse’s income — if they meet these requirements.
- The couple must file a joint federal income tax return
- The working spouse must have enough earned income to make any IRA contributions on behalf of the nonworking spouse, or, if both spouses are contributing, enough income to support both spouses’ contributions
- Assuming enough earned income, each spouse can contribute up to $6,000 (plus $1,000 if turning age 50) for 2019. This limit applies to traditional and Roth IRA contributions combined
- The spouse receiving a traditional IRA contribution must be under age 70 ½ for the entire year
- To be eligible for Roth IRA contributions, the couple must also satisfy income requirements.
Roth IRA income restrictions
The amount that an individual is eligible to contribute to a Roth IRA depends on the amount of the couple’s modified adjusted gross income (MAGI). If the couple’s joint MAGI for a tax year is less than the IRS phase-out range, each spouse can make the maximum Roth IRA contribution allowed for that tax year (assuming enough MAGI to support both spouse’s contributions). If it’s above the phase-out range, neither spouse is eligible to contribute to a Roth IRA. Keep in mind that they could still contribute to a traditional IRA, if under age 70 ½. If the couple’s joint MAGI falls within the phase-out range, their maximum contribution amount is reduced. The MAGI phase-out range is subject to cost-of-living adjustments each year.
Traditional IRA income tax deductions
Note that separate MAGI phase-out ranges apply to traditional IRA contribution deductions — another way for non-working married individuals to potentially benefit when saving for retirement with an IRA. The ability to take a federal income tax deduction for a traditional IRA contribution — if eligible — appeals to many savers. But deduction eligibility depends on whether either spouse is an “active participant” in an employer-sponsored retirement plan. An active participant is generally making or receiving contributions to her retirement plan accounts for the applicable year. Because active participants have access to a workplace retirement plan, the IRS uses its MAGI to determine whether each spouse can take a full deduction, a partial deduction or no deduction at all.
No minimum required
Regardless of which IRA a couple chooses to, the main thing is to contribute — even if it’s a small amount. There is no minimum amount that must be contributed to either type of IRA. Couples can contribute whatever they’re comfortable with, up to the previously described limit. For those concerned about not having enough to set aside in an IRA during a career break, contributing even just $500 or $1,000 for the year will still make a difference.
It certainly beats not saving at all.
SOURCE: Van Zomeren, B. (9 December 2019) "IRA spousal contributions can mitigate the high cost of women’s work breaks in retirement plans" (Web Blog Post). Retrieved from https://www.benefitnews.com/opinion/ira-spousal-contributions-can-mitigate-cost-of-womens-work-breaks-in-retirement
IRS Announces 2015 Retirement Plan Contribution Limits
Source: ThinkHR.com
On October 23, 2014 the Treasury Department announced cost-of-living adjustments affecting dollar limitations for pension plans and retirement accounts for tax year 2015. The following is a summary of the changes that impact employees:
401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plans
- The elective deferral (contribution) limit increased from $17,500 to $18,000.
- The catch-up contribution limit for employees aged 50 and over who participate in these plans increased from $5,500 to $6,000.
Individual Retirement Arrangements (IRAs)
- The limit on annual contributions remains unchanged at $5,500.
- The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.
Simplified Employee Pension (SEP) IRAs and Individual/Solo 401(k)s
- Elective deferrals increase from $52,000 in 2014 to $53,000 in 2015, based on an increased annual compensation limit of $265,000, up from $260,000 in 2014.
- The minimum compensation that may be required for participation in a SEP increases from $550 in 2014 to $600 in 2015.
SIMPLE (Savings Incentive Match Plan for Employees) IRAs
- The contribution limit on SIMPLE IRA retirement accounts for 2015 is $12,500, up from $12,000 in 2014.
- The SIMPLE catch-up limit is $3,000, up from $2,500 in 2014.
Defined Benefit Plans
- The basic limitation on the annual benefits under a defined benefit plan is unchanged at $210,000.
Other Changes
- Highly-compensated and key employee thresholds: The threshold for determining “highly compensated employees” increases from $115,000 to $120,000 in 2015; the threshold for officers who are “key employees” remains at $170,000 for 2015.
- Social Security Cost of Living Announcement: In a separate announcement, the Social Security Administration increased the Taxable Wage Base from $117,000 in 2014 to $118,500.
- The maximum “Old Age, Survivor and Disability Insurance” (OASDI) tax will be $7,347 for both employers and employees; and
- Hospitalization Insurance (Medicare) tax continues to apply to all wages.
The IRS pension plan limits announcement with more details is available here.
The Social Security Administration Fact Sheet outlining the 2015 changes can be found here.
