Is it important to factor in safety from creditors during a 401(k) rollover? How safe was the money in the 401(k) and how safe will it be in an IRA? How important is it to consider this as a financial advisor?
What is protected in a 401(k)?
To put this into perspective, a 401(k) account is generally very far out of reach from creditors. ERISA protects fund in a 401(k) through an anti-alienation provision. This means that most any creditor will be unable to touch money that’s in a 401(k) account. It has some of the highest level of protections against creditors.
What is protected in an IRA?
However, when these funds are rolled over into an IRA, they might lose some of their protections under this 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 1st, 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 me?
So why is it important to consider this when proposing a rollover for an investor? Well because of many advisors’ new status as fiduciaries (as of DOL June 9th rule), affected advisors now need to determine suitability of an investor. The DOL states that financial advisors need to determine the client’s individual needs and circumstances. If they are an investor with debt or in a position that predisposes them to debt, that affects their suitability for a rollover into an IRA. Each investor’s situation needs to be evaluated on an individual level. In addition, does this client have outstanding loans in their current 401(k) 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 401(k)? 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 to act as a proper fiduciary. As an advisor and a fiduciary, if you recommend your investor rollover into an IRA from their 401(k) even though they had questionable suitability, you could be at risk or private action.
What can I do?
So, 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 services you are offering in a rollover. It is not just a number of different service line items, but their importance and whether investor can obtain them without moving the assets to you. You can only do 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 it may be important to them, it is best to not move the money outside of the safe haven of a plan.
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.
Don’t catch yourself in a fiduciary breach because you didn’t have a platform to prove your fiduciary efficacy. Document everything quantitatively and qualitatively with RiXtrema’s IRAFiduciaryOptimizer (Video HERE)!