401K and BANKRUPTCY - CREDITOR CLAIMS CAN WIPE OUT YOUR 401K - Better look carefully at this.
FOUR CENTS ON THE DOLLAR FOR YOUR ENTIRE LIFE SAVINGS!Debtors have hit a fork in the road. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (effective October 17, 2005) clarifies the rights of debtors and expands the protections their retirement assets have in federal bankruptcy proceedings bankruptcy proceedings.
The bankruptcy procedure is: a) filing a petition (voluntary or involuntary) to declare a debtor person or business bankrupt, or, under Chapter 11 or 13, to allow reorganization or refinancing under a plan to meet the debts of the party unable to meet his/her/its obligations. This petition is supposed to include a schedule of debts, assets and income potential.. But outside of federal bankruptcy things remain murky, and there still is uncertainty about whether retirement funds are subject to state attachment and garnishment - Garnishment Money is what is withheld from an individual's paycheck and remitted to another party, usually a creditor.
EXCLUSION IN BANKRUPTCY
The new law protects retirement funds by excluding them from federal bankruptcy estates. It applies to any fund or account that is tax-exempt under
* IRC section 401(a)--tax-qualified retirement plans
* Qualified retirement plan
* A retirement plan established by employers for their employees that meets the requirements of Internal Revenue Code Section 401(a) or 403(a) and is eligible for special tax considerations. The plan may provide for employer contributions, as in a pension or profit-sharing plan, as well as employee contributions. Employers can deduct plan contributions made on behalf of eligible employees on the business's tax return as business expenses.BUT GUESS WHAT. YOU CAN BET THERE are loopholes in qualification requirements and you will lose your SAVINGS. HOW DO WE KNOW?
..... Click on the link above for more information. (pensions, profit-sharing and IRC section 401(k) plans).
* IRC section 403(b)--tax-sheltered annuity plans generally available to individuals working for IRC section 501(c)(3) employers.
* IRC section 457(b)--deferred compensation plans for employees of-tax-exempt and state and local government employers.
The extent of the bankruptcy exclusion for an IRC section 408 IRA varies. IRAs created under an employer-sponsored IRC section 408 SEP IRAs and SIMPLE IRAs
Simple IRA
A salary deduction plan for retirement benefits provided by some small companies with no more than 100 employees., as well as pension, profit-sharing or 401(k) funds transferred to a rollover IRARollover IRA
A traditional individual retirement account holding money from a qualified plan or 403(b) plan. These assets, as long as they are not mixed with other contributions, can later be rolled over to another qualified plan or 403(b) plan. Also known as a conduit IRA...... Click the link for more information., enjoy an unlimited exclusion from the federal bankruptcy estate. The U.S. Bankruptcy Code now also excludes traditional IRAs and Roth IRAs. These IRAs, which workers create and fund themselves, are subject to an aggregate $1 million exclusion limitation (adjusted for inflation and subject to increase if the bankruptcy judge determines that the "interests of justice so require"). The annual contributions individuals make to traditional or Roth IRAs ranged from $2,000 to $3,000 for pre-2005 years, and to $4,000 in 2005, so there is little danger of debtors' reaching the million-dollar exclusion amount.
Under the new law, a rollover from a SEP or SIMPLE IRA into an IRA appears to receive only $1 million of protection. Bankruptcy Code section 522(n) allows a general unlimited exclusion for rolled-over qualified retirement plan wealth but does not sanction IRC section 408(d)(3) rollovers. Clients with SEP or SIMPLE IRA assets under $1 million can roll over these assets and avoid the potential problems with SEP and SIMPLE IRAs outside of bankruptcy discussed below.
Case law and Department of Labor regulations have held that a qualified retirement plan that benefits only the business owner and spouse was not an ERISA ERISA - Employee Retirement Income Security Act of 1974
..... Click the link for more information. plan and did not qualify for ERISA antialienation protections either inside or outside of bankruptcy. The act now eliminates this concern for federal bankruptcy proceedings, as such plans now do qualify.
Practical tip. Because of the unlimited exclusion for qualified retirement plan assets transferred into a rollover IRA, CPAs should always ensure that rolled-over retirement wealth is segregated in a rollover IRA that is distinct from other traditional or Roth IRAs that the debtor may own. SEE ESTATE PLANNING.
PROTECTIONS OUTSIDE OF FEDERAL BANKRUPTCY
The new act does not address debtors' retirement funds that are involved in state law insolvency, attachment or garnishment proceedings. In that case a compilation of ERISA, case law and state law comprises the relevant authority. The major concerns are regarding owner-only plans and IRAs. Retirement funds also can be attached through qualified domestic relations domestic relations n. a polite name for the legal field of divorce, dissolution, annulment, child custody, child support and alimony. (See: divorce) orders and federal tax hens in or outside of a bankruptcy.
SEP AND SIMPLE IRAs
Employer-sponsored SEP and SIMPLE IRAs are treated differently from individually created and funded traditional and Roth IRAs. ERISA defines a "pension" plan under its jurisdiction as any "plan, fund or program that is established or maintained by an employer that provides retirement income to employees." Typically pension, profit-sharing and section 401(k) plans qualify. The Labor Department and the Federal Court of Appeals for the Tenth Circuit (in Garratt v. Walker) held that SEP and SIMPLE IRAs also are ERISA pension plans because they are arranged by the employer, even though the contributions are immediately allocated to the employee's IRA.
Generally, ERISA pension plans receive extensive antialienation protection from creditors. However, this protection does not extend to an IRA, including a SEP or SIMPLE IRA, even if it qualifies as an ERISA pension plan. ERISA also contains specific preemption provisions that supersede and void state law protections specifically afforded to retirement arrangements that are ERISA pension plans (ERISA section 514(a)).
Thus, the SEP and SIMPLE IRA are at an impasse outside of bankruptcy. They are ERISA pension plans--but do not qualify for ERISA antialienation protections. Moreover, any state law protections may be preempted, and a creditor may be able to bring a successful state action state action n. in Federal Civil Rights Acts, dating back to 1875, any activity by the government of a state, any of its components or employees (like a sheriff), who uses the "color of law" (claim of legal right) to violate an individual's civil rights. Such "state action" gives the person whose rights have been violated by a governmental body or official the right to sue that agency or person for damages. (See: civil rights) against these assets.
NON-SEP AND SIMPLE IRAs
An individually established and funded traditional or Roth IRA is not an ERISA pension plan, so state laws can apply to protect them. Usually the owner's state of residency determines whether the IRA is protected. For example, Ohio law specifically exempts both traditional and Roth IRAs from execution, garnishment, attachment or sale to satisfy a judgment or order, with no cap. For a list of state laws protecting IRAs, go to www.aicpa.org/pubs/jofa/jan2006/ altieri.htm.
Practical tip. CPAs should advise their clients that assets rolled over from a SEP or SIMPLE IRA into a rollover IRA should, at that point, no longer be part of an employer-maintained arrangement and therefore would lose their characterization as parts of an ERISA pension plan. The rolled-over assets would not then be subject to ERISA preemption and could take advantage of state law protections for non-SEP and SIMPLE IRAs. If there is less than $1 million of such rolled-over wealth, the resulting rollover IRA would be afforded unlimited protections under nonbankruptcy proceedings in states such as Ohio and protected in a bankruptcy proceeding.
As an example, Mark Smith is a small business owner who has $500,000 invested in a SEP IRA established by his company. Under his state's law, assets held in an IRA generally are exempted from any creditor claims. Mark is successfully sued for $300,000 of damages in state court and is not filing for federal bankruptcy protection.
This matter is outside of federal bankruptcy law, and the new bankruptcy protections therefore do not apply. Because Mark's money is in a SEP IRA, it constitutes an ERISA pension plan, preempting any state law directly protecting it, and it would not qualify for the antialienation protections usually afforded ERISA plans. The judgment creditor therefore may successfully attach Mark's IRA.
If Mark transferred the money in his SEP IRA to a roUover IRA, it no longer would qualify as an ERISA pension plan. Thus it would be protected from creditor claims up to $1 million either inside a bankruptcy proceeding or possibly to an unlimited extent outside of bankruptcy under applicable state law.
Note that in Rousey v. Jacoway, the Supreme Court held that IRAs are a "similar plan or contract" to pension and profit-sharing plans under the limited exemption in the Bankruptcy Code. This decision, although largely irrelevant since the new law, may be authoritative in states that protect pension and profit-sharing plans without specifically protecting IRAs. In these states the fact that the Supreme Court equated IRAs with traditional retirement plans might be persuasive in a nonbankruptcy proceeding involving traditional or Roth IRAs.
CPAs should note the change that has occurred since the advent of the new bankruptcy law. Wealth residing in qualified retirement plans (pension, profit-sharing and section 401(k) plans) continues to possess the most extensive debtor protections both in and outside of a bankruptcy proceeding. A distinct IRA into which qualified retirement plan assets are rolled, an asset frequently attacked under pre-act bankruptcy law, would constitute as strong a protected reservoir of wealth under the new post-act unlimited exclusion for such IRAs in a federal bankruptcy proceeding. Similarly, in states providing strong IRA protection (such as Ohio), the rollover IRA would enjoy unlimited protection from creditors in a nonbankruptcy proceeding.
OWNER-ONLY PLANS
ERISA and the Internal Revenue Code's broad antialienation protections generally have protected a debtor's pension plan, profit-sharing or 401(k) plan benefits from creditor claims both in and outside of bankruptcy. However, under case law and Department of Labor regulations, a plan that benefits only an owner and his or her spouse is not an ERISA plan, and so does not qualify for antialienation protections under Title I of ERISA.
As noted above, owner-only plans are not at risk in bankruptcy proceedings. Outside of bankruptcy, the owner-only category does not apply if nonowner participants are added to the plan. So the easiest way to protect funds in such plans is by adding other participants. Alternatively, one could make the same argument, as was just examined with regard to traditional and Roth IRAs outside of bankruptcy, that since owner-only plans are not ERISA plans, state law protecting retirement plans would not be preempted.
THE CURRENT STATE OF PROTECTIONS
Qualified retirement plans and IRAs are protected under the new bankruptcy legislation. Outside of bankruptcy, ERISA provides nearly unlimited antialienation protection to qualified retirement plans (pensions, profit-sharing and 401(k) plans). State law generally protects traditional and Roth IRAs. SEP and SIMPLE IRAs and owner-only plans, however, require additional planning to insulate them from creditor claims.
Amount of Money in IRAs
IRAs are the single largest component of the U.S. retirement market, holding $3.5 trillion of assets at year-end 2004 (out of a total of $12.9 trillion of retirement plan assets). Investors hold most ($3.2 trillion) of their IRA assets in traditional IRAs, which they fund with rollovers from employer-sponsored retirement plans and/or contributions.
Source: Investment Company Institute, August 2005, www.ici.org/stats/latest/1fm-v14n4.pdf.
EXECUTIVE SUMMARY
* THE NEW BANKRUPTCY LAW protects tax-qualified retirement plans-pensions, profit-sharing and 401(k) plans--from creditors in bankruptcy.
* SEP AND SIMPLE IRAs ARE excluded from bankruptcy estates under the new law, even if they qualify as ERISA pension plans.
* TRADITIONAL AND ROTH IRAs that are created and funded by an individual are subject to an aggregate bankruptcy exclusion of $1 million.
* SEP AND SIMPLE IRAs, BEING ERISA plans, but not enjoying ERISA antialienation protections, may be subject to attack in a state action, since any protecting state law may be preempted by ERISA.
* TRADITIONAL AND ROTH IRAs are not ERISA pension plans. They are protected in non bankruptcy proceedings by any state laws specifically protecting IRAs since such state laws are not preempted by ERISA.
"Protecting Retirement Plan Assets from Creditor Claims"JofA, Apr. 05, page 34, www.aicpa.org/pubs.jofa/apr2005/naegele.htm.-------------------------------
My company is being liquidated. Does that mean my retirement fund is at risk?
Not to worry. Creditors may be flocking like vultures over the remains of your company's assets, but the vested portion of your account (i.e., the amount that you would be able to walk away with if you quit your job under normal circumstances) should be safe and sound. After all, that money belongs to you -; even if it's partially made up of funds contributed by your employer. And creditors can't get their sticky hands on those savings since all 401(k) monies are held in a trust at a designated financial institution (that is, a company other than your employer).
There are a couple of exceptions. First and foremost, if you're holding company stock within your 401(k) you could face trouble. When a company goes bankrupt, its stock generally gets crushed. And unfortunately, if your company match comes in this form, there may be little you can do to prevent this type of disaster. (This is part of the reason why we rarely recommend holding more than a small amount of company stock in your 401(k), if you have the choice.)
Secondly, many company managers have been known to illegally dip into a 401(k) or pension fund in times of trouble, says Ted Benna, president of 401(k) Assocation. If that were to happen in your case, it would be a matter for the courts. But rest assured that it's rare.
Another potential problem, says David Wray, president of the Profit Sharing/401(k) Council of America, is when a company declares bankruptcy during the time when your 401(k) contribution has been taken out of your paycheck, but has yet to be deposited to the trust. Contributions go through an administrative process, Wray explains, that can take anywhere from one day to a month, depending on the size of the company you work for. If your company files for Chapter 11 or Chapter 7 in the meantime, your contribution could get mired in the bankruptcy proceedings.
If your contribution is caught in limbo, there isn't much you can do except wait in line to collect what you're due. Luckily, employees have higher priority than most other creditors, so there's a good chance you can get that money, even if you'll have to wait awhile, says Wray.
But even though you can be confident about walking away with the vested portion of your portfolio, that doesn't mean you can rest easy. If your company is going through Chapter 7 bankruptcy and is liquidating all its assets, it's likely that your 401(k) plan will be terminated and you'll receive a lump-sum distribution, says Stuart Lewis, head of the pension group at Washington, D.C., law firm Silverstein and Mullens (a division of Buchanan Ingersoll). You'll then have to choose between rolling over your money into an IRA or a new employer's 401(k) (if you've got one), or taking your money in cash (which would mean you owe taxes plus a 10% penalty for an early withdrawal if you're under 59 1/2 years old).
Remember, too, that you have only 60 days to roll the money over into another tax-deferred account. Fortunately, your decision should be pretty simple: It almost always makes the most sense to roll the account over into an IRA. After all, your 401(k) probably had about 10 investment options, but with an IRA you've got thousands to choose from. For more on this, see our story "Rolling Over Retirement Accounts." And if you're over age 59 1/2 and want to take a lump-sum distribution (or if you're 55 or older and thinking about retiring), you'll want to read "How to Handle a Lump-Sum Distribution."
THE REMEDY? INVEST IN RELATIVES instead of all these funds. I mean TALENT! You may have a nephew who's good with machinery. Send him to AIR CONDITIONING TRADE TECH CLASS. Start up a local businesss for something FOLKS REALLY NEED.
We should tout OPRAH onto a show about INVESTING LOCALLY. The whole concept. Show the viewers a dozen people who didn't put their life savings in bonds (inflation creeps up and takes the profits) or in stock markets, (Wall Street Fraud, Inflation both dice the profits.). Or in 40K's and ROTHS which BANKRUPTCY will take and we could all be going bankrupt with things as they are now.
The concept is that Oprah would show us people who invested in talent. Their nephew's first business, their SON's INVENTION, or SERVICE INDUSTRY. Oprah should Show us the reason why seniors should take their extra cash and create a business, even if it's just a kid's garage business. The concept is they Invest in talent. Find someone who just graduated school in something very high tech like PC's dressmaking, nature healing, car repair and set them up in a small business. Do their books. Salary them once a week Friday nite at closing time. Tell them that after all expenses, when the business goes into profits, you do a half and half fifty fifty split. GET THEM TO SIGN THAT. In the prenup contract, put this: If you walk out of the business, I get to hire someone ELSE to go into it to save MY CASH INVESTMENT. That's a NO OUT WITHOUT LOSS FOR THE PARTNER clause. The clause must stipulate that IF THEY WALK, they will take nothing of the business at that point. That clause keeps them in their place. They may do a lot of work 5 days a week, but you created this business and their doing it so they gotta salute that fact.
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