Federal Creditor Protection
Company plan assets receive federal creditor protection. State law protects IRAs. If a state offers limited or no creditor protection, and there are malpractice, divorce, or creditor problems or other types of lawsuits, creditor protection should be considered. On April 4, 2005, The U.S. Supreme Court ruled that IRAs have federal creditor protection in bankruptcy. On April 20, 2005, the Bankruptcy Law created federal creditor protection for IRAs in bankruptcy situations only; not for other types of judgments. The Bankruptcy Law supersedes the Supreme Court ruling.
You should learn your state’s creditor protection status for IRAs and Roth IRAs. You also want to find out if protection is limited, say to $500,000 of IRA money. By knowing this information, you will be able to provide essential advice to a client with legal or creditor problems who is considering an IRA rollover. This will enhance your relationship with that client, especially if it turns out that your knowledge helped the client keep his retirement account from possible attachment.
A client might leave money in their company plan if they have plan loans or if they may need to borrow from the plan in the future. In these uncertain times, the ability to borrow from a company plan, albeit a last resort, could be a serious consideration.
Plan Life Insurance
Clients cannot buy life insurance in IRAs, but money in company plans can be invested in life insurance. Life insurance offered through a company plan may be the only life insurance a client can qualify for or pay for. It may be costly to continue the insurance if they leave the plan.
Will Client Be Working Again?
If a client has been laid off, and is looking for new employment, they might want to leave the money in the company plan so they can roll it over to a new employer’s plan once they find a new job. Once funds are rolled to a new employer’s plan, a client can delay age 70½ required distributions from that company plan if they are still working for that company. The “still working” exception does not apply to IRAs. The new portability
rules minimize this consideration because as of 2002 individuals can roll any taxable IRA funds to a company plan and delay required distributions on those funds. In the past, only conduit IRAs could be rolled to a company plan.
Age 55 Plan Exception to the 10% Penalty
If a plan participant was at least 55 years old when he left his job and needs to tap retirement funds immediately, he should leave the money in his company plan and take his withdrawals from there. Distributions from a company plan will be subject to tax but no 10% penalty. If the participant rolls his plan funds to an IRA, withdrawals before age 59½ will be subject to the 10% early withdrawal penalty unless one of the other exceptions applies. The age 55 exception does not apply to IRA distributions.
Age 50 for Public Safety Employees
For state and local public safety employees, the funds can be withdrawn penalty free if the separation from service was in the year the employee turned age 50 or older. (Pension Protection Act of 2006).
Distributions taken after August 17, 2006 from a governmental defined benefit pension plan by public safety employees who separate from service at age 50 or older are exempt from the 10% penalty.