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Watch your IRA! A law before Congress
may give creditors limited access to IRA accounts, in the event that you declare
bankruptcy. This proposal would mark a fundamental change in the direction of federal
retirement policy.
Some financial planners and retirement plan
advocates are seeing red. Others say it's about time Americans took responsibility for
their financial habits.
If your employer offers a 401(k), 403(b), 457, or pension
plan, creditors can't touch the money you contribute to it. Federal law protects it.
IRAs are a different story. They have some chinks in their
armor that two senators want to open further.
Sen. Charles Grassley, R-Iowa, and Sen. Jeff Sessions,
R-Ala., are talking about adding language to the Bankruptcy Reform Act of 2000 that would
allow creditors to force you to pay up from your IRA if you declare bankruptcy, if your
balance is over a certain amount.
For 401(k) and other defined-contribution plan
participants, such a law could have a significant potential impact because many workers
roll retirement assets into IRAs when they leave their job or retire. This has many
retirement and investment advisors up in arms, decrying the possible end of the sanctity
of retirement accounts.
"This would be a change in the nation's retirement
policy," said James Delaplane, vice president, retirement policy, with the
Association of Private Pension and Welfare Plans (APPWP). Traditionally, retirement law
has favored more, not fewer, protections for nest eggs, he says.
The Senators' Case
Currently, money in 401(k) and pension plans is protected
from creditors by the Employee Retirement Income Security Act (ERISA). This means if you
file for bankruptcy, your creditors can't force you to use your retirement assets to pay
your debts. You also can't use these retirement assets as collateral for a loan. And,
ERISA protections don't cover all 403(b) and 457 plans. (If you have one of these plans
you should check with your employee benefits administrator to see whether it is covered.)
ERISA protection doesn't extend to IRA accounts, however.
State law dictates IRA account protection. The proposed legislation would override state
law.
Grassley and Sessions worry that credit scofflaws might try
to declare bankruptcy and hide their assets in retirement-plan protections to shield their
assets if they declare bankruptcy.
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"Our plan would let an individual
in bankruptcy keep $1 million in a retirement account, while at the same time prohibiting
that debtor from stashing millions more in retirement accounts as a way to avoid paying
what's owed to creditors."
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| —Sen. Charles
Grassley, R-Iowa and Sen. Jeff Sessions, R-Ala. |
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The current proposal protects retirement assets of $1
million or less held by folks age 65 or older from creditors. Bankruptcy-court judges
would have discretion to allow debtors to keep more than $1 million.
"Our plan would let an individual in bankruptcy keep
$1 million in a retirement account, while at the same time prohibiting that debtor from
stashing millions more in retirement accounts as a way to avoid paying what's owed to
creditors," Grassley and Sessions said in a statement.
This "millionaire's cap" protection would decline
in equal amounts from $1 million for a debtor age 65, to $250,000 for a debtor age 21.
The Advisors Response
Grassley's and Sessions' reasoning that workers could stash
huge amounts of money in retirement accounts is flawed, retirement experts say. These
types of tax-deferred plans have strict contribution limits already in place. Currently,
the maximum a single person can contribute to an IRA in a year is $2,000 and the maximum
contribution to a 401(k) plan is $10,500. It is possible for a worker to move a large sum
of money into an IRA, but this could only be from another qualified tax-deferred plan.
The AARP, which represents older Americans, isn't happy
with the proposed legislation.
"We would like to have this money for retirement
security," said David Certner, senior consultant for economic issues with the
nonprofit group AARP.
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Currently, the maximum a single person can
contribute to an IRA in a year is $2,000 and the maximum contribution to a 401(k) plan is
$10,500.
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As he points out, few people contribute to retirement plans
in order to dodge creditors.
"It's funny, but most of the people we see that save
into a 401(k) plan aren't going to declare bankruptcy," said Carrie Coghill, a
certified financial planner and senior vice president of D.B. Root & Co., of
Pittsburgh.
Coghill worries that such a law could further hinder
low-wage workers' ability to save for retirement. They could be placed at a double
disadvantage. First they have trouble saving for retirement, then some of their savings
could be lost to creditors.
Grassley responded in a statement that his proposed reforms
wouldn't affect those with smaller IRA account balances.
Still, hard-working Americans who diligently save could
find themselves surpassing the "millionaire's cap" by the time they reach
retirement, said Martha Priddy Patterson, analyst, human capital advisory services, with
Deloitte & Touche.
Who Pays What
At the time of this writing, it's unclear as to who would
pay any early withdrawal penalty taxes if a debtor younger than 59ý were forced to pull
money out of an IRA. Nor is the language clear on who pays the income tax on such a
withdrawal.
But, it's likely the tax would still be owed. "At the
end, you are giving the IRS a big slice of the money," Delaplane said.
The Bankruptcy Reform Act is currently in what is known as
the final stages of conference committee. That's the point at which members from the House
of Representatives and Senate resolve discrepancies between their versions of the similar
legislation before sending the final bill to the President for signature into law.
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"If this (law) is enacted, I can
never recommend that anyone roll over money from a 401(k) to an IRA plan."
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| —Martha Priddy
Patterson, analyst, human capital advisory services, with Deloitte & Touche. |
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This proposal is one of a handful of issues to be resolved
before the bill is finally sent to the President. The Clinton Administration has spoken
out against this proposal, and this issue could be enough to prevent a presidential
signature, Delaplane said.
The current IRA proposal is less sweeping than an earlier
one that might have given creditors access to defined-contribution accounts like 401(k)
plans and defined-benefit accounts like pensions. An earlier version of the proposal would
have even permitted workers to sign away their retirement benefit protections if they did
something as benign as signing a credit-card application.
"That's absolutely ridiculous," Patterson
exclaimed.
Even as 401(k)- and pension-plan participants heave a sigh
of relief that their benefits would be untouched, the law could ultimately affect them.
Many workers commonly roll their benefits into an IRA when they leave their employer for
retirement or take a new job.
"If this (law) is enacted, I can never recommend that
anyone roll over money from a 401(k) to an IRA plan," Patterson said.
The Heart of the Problem
Some feel working Americans must deal with such adult
problems as debt and shouldn't be able to evade creditors.
Robert Weagley, a certified financial planner and associate
professor of consumer and family economics at the University of Missouri, is one of those.
"On the surface it seems you're taking money away from
the security of the family so you can reward the evil lenders. But, assuming the product
was satisfactory, (the individual) has an obligation to repay the money," he said.
He points out that getting into debt is a personal hardship
created by the individual, not the banks. For that reason, retirement assets shouldn't
enjoy any special protections, Weagley adds.
The real solution is for Americans to learn when to
appropriately use their credit cards, a tougher fix to this problem, he said.
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