Planning for retirement plans is a challenging undertaking. Retirement plans provide owners with many advantages, including income tax, estate tax and asset protection. The income tax rules applicable to retirement plans, specifically the rules dealing with required minimum distributions are very technical. The estate planning uses of retirement plans are also present, including the use of retirement plans to fund the bypass trust and to qualify for the marital deduction. These considerations are beyond the scope of this outline.
The asset protection advantages of retirement plans are the focus of the following discussion. Retirement plans present a major planning opportunity for asset protection purposes. Both federal and state laws favor retirement plans, and allow owners of such plans a certain sense of security with respect to the assets within the plan.
From an asset protection standpoint retirement plans are broken down into two categories: qualified and nonqualified. This is the same distinction that is made for income tax purposes.
Qualified plans are a very important asset protection tool because such plans are required to include anti-alienation provisions pursuant to the Employee Retirement Income Security Act of 1974[1] (“ERISA”) and therefore are excluded from the debtor’s bankruptcy estate. Commonly used plans which are protected by ERISA include defined benefit plans (like a pension plan), defined contribution plans (like a profit sharing plan), and plans to which employees make voluntary contributions (401(k) plans). Similarly, for a plan to be treated as “qualified” under the Code, it must contain anti-alienation provisions.[2]
Protection of ERISA is afforded to employees only and does
not cover employers. The owner of a
business is treated as an employer, even though he may also be an employee of
the same business, as in a closely-held corporation. Accordingly, ERISA protection does not apply
to sole proprietors, to one owner businesses, whether incorporated or
unincorporated, and to partnerships, unless the plan covers employees other
than the owners, partners and their spouses.[3] A sole proprietor can never be protected under
ERISA (because you cannot be your own employee). For all other businesses where the owner is
seeking ERISA protection, non-owner employees (other than spouses) should be
covered under the plan to maximize the plan’s asset protection benefits.
Section 541(c)(2) of the Bankruptcy Code provides an exclusion[4] from the debtor's estate of a beneficial interest in a trust that is subject to a restriction that is enforceable under “applicable nonbankruptcy law.” The Supreme Court held that “applicable nonbankruptcy law” includes not only traditional spendthrift trusts, but all other laws, including ERISA provisions that require plans to include anti-alienation provisions.[5] Accordingly, all plans that are required to include anti-alienation provisions pursuant to ERISA are excluded from the debtor’s bankruptcy estate.
Protection afforded by ERISA does not apply only in a bankruptcy setting. Even outside of bankruptcy, a creditor cannot reach the assets of an ERISA plan.[6]
Perhaps the most telling evidence of ERISA’s protection is the Supreme Court’s decision in Guidry v. Sheetmetal Pension Fund.[7] In Guidry a union official embezzled money from the union and transferred it to his union pension plan. The union official was convicted of the crime of embezzlement and the union attempted to recover the embezzled proceeds from the pension plan. Other than the fact that the proceeds were embezzled, the transfer to the pension plan was a fraudulent conveyance.
The Court held that the money in the pension plan could not be reached by creditors, whether by way of a constructive trust, writ of garnishment, or otherwise, because of ERISA’s anti-alienation requirements. Prior to that, various courts and states carved out exceptions to ERISA’s anti-alienation provision. The Court declared that exceptions to the anti-alienation rules were not justified by ERISA.[8] The protection afforded by ERISA’s anti-alienation provisions applied regardless of how distasteful the debtor's behavior may have been or any applicable state public policy reasons (including a state’s fraudulent transfer laws).
In response to Guidry and other cases like Guidry, Congress carved out several exceptions to the protection afforded by ERISA. These exceptions include: (i) a criminal violation of ERISA; (ii) a judgment, order, decree, or settlement agreement in connection with a violation of the fiduciary provisions of ERISA; or (iii) a settlement between the Secretary of Labor and the participant or settlement agreement between the Pension Benefit Guaranty Corporation and the participant in connection with a violation of ERISA’s fiduciary duties. These exceptions obviously apply only to criminal conduct and only as such conduct relates specifically to an ERISA plan. Consequently, Guidry and its progeny continue to provide full protection to ERISA plans.
How important is it for a would-be debtor to keep money in a qualified plan? Certainly, at the time of a collection action, the debtor should have its money in a qualified plan. However, because the tax rules allow for such easy rollovers between qualified and nonqualified plans, in either direction,[9] and because ERISA trumps fraudulent transfer laws, debtors may keep their retirement funds in nonqualified plans. Prior to a creditor’s collection action the debtor should roll the funds into a qualified plan.
It should be noted that ERISA’s anti-alienation provisions do not apply to traditional support obligations for spouse and children. Also, under ERISA, retirement benefits can be divided pursuant to a qualified domestic relations order issued in connection with provision for child support, alimony payments, or marital property rights.[10] ERISA also does not protect monies distributed form the plan to the plan’s beneficiaries.
The final exception to ERISA’s protection are federal tax liens. There is no statutory exemption for ERISA plans from federal liens and levies and the courts have held that the Service may collect against an ERISA plan.[11]
Nonqualified plans are generally not protected by ERISA, but may be protected by state statutes that exempt retirement plans from claims of creditors. The protection afforded by each state varies, based on the applicable statute and its interpretation by the courts.
For example,
What is reasonably necessary is determined on a case by case basis, and the courts will take into account other funds and income streams available to the beneficiary of the plan.[15] Debtors who are skilled, well-educated, and have time left until retirement are usually afforded little protection under the California statute as the courts presume that such debtors will be able to provide for retirement.[16]
In
The question of what constitutes a retirement plan was considered in Yaesu Electronics Corp. v. Tamura.[17] In that case the court held that the design and purpose of an IRS-qualified plan was not for retirement, since the debtor “admitted that he had never had a retirement account,” and “conceded that his purpose in establishing the [Retirement] Plan was not to save money to use for his retirement but to take advantage of the tax laws and to save money for his children.” Further, there was no evidence that the debtor used the money for retirement even though he was retired.
California courts have set forth several relevant factors to determine whether a nonqualified plan constitutes a “private retirement plan”: (i) the purpose of any withdrawals from the retirement plan; (ii) whether the applicable procedures were followed, in this case for withdrawals; (iii) the frequency of withdrawals; (iv) whether the retirement plan was used to shield or hide funds from creditors or the bankruptcy court; (v) whether any withdrawals diminished or will diminish the assets to such an extent that they are inconsistent with the majority of the assets being used for long-term retirement purposes; and (vi) whether the debtor exercised such control over the plan so as to show a non-retirement purpose.[18]
Accordingly, while
Nonqualified plans garner additional protection from the
fact that the underlying trust is often spendthrift in nature. Which means that the plan will contain its
own anti-alienation provision. Thus, the
Ninth Circuit held that the assets of a nonqualified plan were protected in
bankruptcy under the
While the spendthrift trust affords beneficiaries strong protection from creditors, it is subject to the prohibition against self-settled trusts. Because retirement plans are frequently established by employees for their own benefit, it would seem that the self-settled trust rules may apply.
In the Ninth Circuit, the prohibition against self-settled
trusts has been modified so that such trusts have an enforceable spendthrift
clause if: (i) the employer, rather than the
participant, makes all contributions, even if such contributions result in a
voluntary reduction of future wages, and (ii) the participant is not entitled
to receive the contributions except indirectly as distributions from the
retirement plan.[20] Thus, the less access the beneficiary has to
plan assets, the more likely the plan will be treated as a valid spendthrift
trust
In carving out this exception to the self-settled trust rules, Ninth Circuit noted the great value our society places on providing for retirement of individuals, and deemed that such value overrides the public policy reasons behind the self-settled trust rules.
It would appear that the protection carved out by the Ninth Circuit to spendthrift nonqualified plans would apply even to plans established by closely held businesses for the benefit of owner-employees, so long as the entity and not the owner-employee makes contributions to the plan.
Clients seeking protection for their retirement plans should always roll-over their IRA to other types of plans. Additionally, converting to an ERISA qualified plans should also be considered, as ERISA plans are immune from fraudulent transfer challenges.
Frequently, financial advisors recommend to their client to
roll their 401(k) and other ERISA-qualified plans into IRAs. In a recent decision, a
[1] 29
[2] Code
Section 401(a)(13).
[3] 29 C. F.
R. Section 2510.3-3(b), 2510.3-3(c); Giardono
v.
[4] An exclusion, as opposed to an exemption, is not limited in amount.
[5] Patterson
v. Shumate, 112
[6] Retirement
Fund Trust of Plumbing v. FTB, 909 F. 2d 1266 (9th Cir. 1990)
(attempts to seize plan benefits pursuant to state tax levy procedures are
prohibited by ERISA’s antialienation
provisions).
[7] 493
[8] However,
the Court made it clear that the domestic relations and child support exceptions
to the antialienation provisions of ERISA continued
to apply.
[9] Code
Section 408(d)(3)(a).
[10] Code
Section 414(p); 29
[11]
[12] CCP
Section 704.115(a).
[13] CCP Section 704.115(d).
[14] CCP Section 704.115(e).
[15] In
re Bernard, 40 F. 3d 1028, 1032–1033 (9th Cir. 1994) (annuity
did not meet the reasonably necessary standard for an individual, age 60, who
earns in excess of $200,000 a year, where he was also entitled to income from
other sources upon retirement, including social security and pension benefits);
In re Spenler, 212 B. R. 625 (9th Cir.
BAP 1997) ($275,000 IRA was not “necessary” within the meaning of CCP Section
704.115(e) where 55-year-old physician who worked approximately 80-90 hours per
week could save for his retirement out of his estimated $250,000 annual income).
[16] In
re Moffat, 119 B. R. 201 (9th Cir. BAP 1990), aff’d, 959 F2d 740 (9th Cir. 1992) (practicing
orthodontist did not need annuity for support).
[17] 28
[18] In
re
[19] In
re Atwood, 259 B. R. 158, 161–162 (9th Cir. BAP 2001).
[20] In
re Kincaid, 917 F. 2d 1168 (9th Cir. 1990).
[21] McMullen
v. Haycock, --