Is a 401(k) Safer Than an IRA?

For example, the more assets you have, the more you may need to worry about legal liability.

That includes all the money you’re saving for retirement. Even among tax-advantaged accounts, there’s a difference between the safety of money inside a 401(k) vs. an IRA.

What’s Safer, a 401(k) or an IRA?

Which is safer, a 401(k) or an IRA?

A Clark listener recently asked the money expert that question.

“My concern is where it’s most protected for potential lawsuits,” Jennifer in Georgia said. “My auto insurance provider has scared me that any future car accident at the fault of anyone in my household could result in me losing everything, including my savings.”

Let’s tackle the lawsuit question first. A 401(k) is more secure than an IRA in terms of protecting your money from creditors. So in the case of a legal settlement against you, or even a bankruptcy, 401(k) money usually is protected while IRA money usually is not.

“It is true in most states a 401(k), and this is not everywhere, a 401(k) has more protection against lawsuits than IRAs,” Clark says.

Clark Almost Always Prefers 401(k) Accounts to IRAs

Setting aside the safety and legal protections of a 401(k) vs. an IRA, you may do well to avoid a 401(k) to IRA rollover.

In addition to offering much higher contribution limits and potentially a company match, completing a rollover takes some work. And it can create tax implications depending on your rollover choices.

“I know there’s a big push by people in the financial business to get you when you change an employer to dump your old 401(k) into an IRA or whatever else they’ve dreamt up for you. But you need to be brought kicking and screaming from going from a 401(k), usually, into an IRA,” Clark says.

“An example where that would be a good choice is if you had a high-cost provider for the old employer 401(k). Then your best move is to a new employer 401(k). Not to an IRA. But if you go to work somewhere else and they don’t have a 401(k) available to you, or it’s a crummy one, then you do consider going from an old employer high-cost 401(k) into an IRA.”

The other reason Clark thinks IRAs are a good idea? If you don’t have a 401(k) available through a job. Or if you max out your 401(k) contributions and you’re income-eligible to contribute to an IRA.

Lawsuits Can Impact Your Assets Beyond Retirement Funds

Whether via an at-fault judgment in an auto accident or some other means, unless every dollar of your net worth is in a legally-protected 401(k), you may still be at risk.

“That’s why you have liability coverage with auto insurance,” Clark says. “If you’re that worried about lawsuits though, you should be worried about all your assets.”

In addition to a good overall insurance plan, if you hold significant assets, you should consider umbrella insurance.

Umbrella insurance kicks in after you've reached the limits of your liability coverage on your homeowners (or renter's) and auto insurance policies.

The types of events that typically fall under liability coverage include:

Umbrella insurance “is not something you buy at Dollar Tree for a dollar and a quarter. It is an insurance policy that covers over all your assets,” Clark says.

Final Thoughts

A 401(k) account typically protects your funds from creditors such as bankruptcy proceedings or lawsuits. Clark also prefers that you prioritize 401(k) accounts ahead of IRAs unless the only 401(k) plan you can access includes expensive fees.

If you hold significant assets, you can be liable outside of your 401(k) money. You want to make sure you’re covered with a strong insurance strategy, including liability coverage on your family’s auto insurance policies.

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