This week, readers continue to search for answers to their most pressing financial questions. Here are the ones that I felt could benefit a cross-section of our readers:
“My wife and I are both retired and have our retirement savings in the Alabama RSA1 and federal TSP programs, both of which claim to have low expense ratios. Is it safe to have our retirement tied up in government sponsored programs? J.L.
J.L. is referring to Retirement System of Alabama’s deferred compensation plan which is available to state employees and the federal thrift savings plan which is similar to a 401k plan but for federal employees. Thousands of Alabamian’s are participating in these plans and I suspect many folks have heightened concern about how safe their money is in the aftermath of Jefferson County’s $3 billion default on their sewer bonds. Both programs do a great job of keeping expenses low and both plans are a ‘safe’ place for your money if you are concerned about a default or bankruptcy of some sort. What you should be concerned about under either plan is the type of investments you have chosen. Both programs offer a range of investment options including stock, bond and fixed rate-oriented securities. Both bond and stock-oriented investments can fluctuate significantly so J.L. should review his allocation and make certain it’s appropriate under his and his wife’s retirement status.
A few weeks ago I answered a reader’s question about whether, since he is retired, should he keep his 401k with his former employer or roll it over to an IRA? I suggested he could possibly cut expenses and certainly increase his investment options by doing the rollover. Another reader asked this follow up question:
“Are they equally protected legally? I believe a 401-k is classified as a pension and hence not subject to legal suits. Is an IRA? I am retired, and understand that only an active employee can get a loan from a 401-K, so that means no advantage over an IRA as to taking a loan out.” M.G.
M.G. does bring up a good point. Defined contribution plans such as 401k’s and 403b’s; Simplified Employee Pension Plans (SEP) and SIMPLE IRAs; defined benefit pensions and profit sharing plans all fall under the Employee Retirement Income Security Act (ERISA) of 1974 and are fully protected against legal judgments except the Internal Revenue Service or a judgment in a divorce (called a qualified domestic relations order or QDRO). Historically, traditional IRAs have fallen under state law for purposes of legal protection. In 2005, congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act which provides that up to $1 million of traditional IRA (or Roth IRA) funds are protected under federal law if you file bankruptcy and 100% of funds rolled over from an ERISA plan are protected as well. However, if you don’t file for bankruptcy, it appears that state law will determine the level of protection for your IRA. State laws can vary widely. For example, according to a bankruptcy attorney I spoke with, Alabama provides for protection for a traditional IRA but not for a Roth IRA (legislation is pending for Roth IRA protection). So, depending on your state laws, leaving your money in your 401k may offer better asset protection. One suggestion is to review your umbrella liability policy and consider increasing the amount of coverage.