By Andy Ives, CFP®, AIF®
Edward was born in 1950. Traditional IRA accounts would not be established until the Employee Retirement Income Security Act of 1974 (ERISA). In 1975, Edward and many other Americans took full advantage of this tax-deferred savings opportunity. The maximum contribution limit in 1975 was $1,500, and Edward contributed the full amount to his IRA every year.
Contribution limits increased to $2,000 in 1982 and to $3,000 in 2002, and each year Edward squirreled away the maximum amount. The over-50 catch-up contribution provision became effective with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) when Edward was already over 50, so he leveraged the new rules to dial up his savings.
With each increase in the annual contribution and over-50 catch-up limits, Edward continued to plow his hard-earned dollars into his IRA. By 2019, when Edward was 69, he had contributed the maximum amount possible that any person could have deposited into an IRA since the retirement tool first became available: $151,500. Of course, during the 40-plus years since his first contribution, Edward experienced ebbs and flows with his investment performance. Through it all, his IRA account had grown significantly.
The $151,500 number is noteworthy when it comes to IRA bankruptcy protection. Even with an average annual return of 6% starting with Edward’s first contribution of $1,500 way back in 1975, his total account value would now be a shade under $500,000. On April 1, 2019, the inflation-adjusted cap on IRA bankruptcy protection will increase to $1,362,800 (up from $1,283,025). This cap applies only to IRA or Roth IRA contributions and earnings on those funds. It does not apply to company retirement plans. Edward’s entire IRA account, which is comprised entirely of contributions and earnings, is protected from bankruptcy.
What if Edward rolled over $3,000,000 into his IRA from his 401(k) and commingled his assets? In that case, even though they were combined, his $500,000 in IRA contributions and earnings would still be considered separate from the 401(k) rollover dollars for bankruptcy protection. The $3 million would not count toward the IRA bankruptcy cap, and Edward’s $500,000 in contributions and earnings would remain fully protected.
Well, what about the $3,000,000 in rollover dollars from his 401(k) – are they protected at all? Under ERISA, the entire $3 million is protected from bankruptcy while in the 401(k)…and the entire $3 million remains protected even after those dollars are rolled over! Yes, you did read that correctly. While IRA contribution/earnings will soon have an increased inflation-adjusted bankruptcy protection cap of $1,362,800, retirement funds in company plans that are exempt from federal income tax have an unlimited amount of protection from bankruptcy. This ERISA protection continues even after the company plan assets are rolled into an IRA.
Fortunately, Edward maintained solid records and had no financial difficulties, so bankruptcy was not an issue. If bankruptcy did rear its head, Edward could easily delineate between IRA contributions/earnings and his 401(k) rollover dollars. If he had hit it big with a savvy stock investment and his IRA contributions and earnings began to creep toward the new $1.362 million cap, it would be important for Edward to understand his potential bankruptcy exposure.
If he desired, Edward could have maintained two IRAs – one for his contributions/earnings and the other for his 401(k) rollover dollars. There is no requirement to do so, but maintaining separate accounts might make things easier for some people.
By the way, Edward still works part time. He realizes that he will turn 70 ½ soon and will no longer be allowed to contribute to a Traditional IRA. He plans to contribute to a Roth, and is having conversations with his advisor about doing partial conversions of his Traditional IRA to a Roth in order to help minimize the tax impacts on his beneficiaries.
But that is another story.