The Monthly Tax and Asset Protection
Newsletter of Klueger & Stein, LLP

December 2009

Asset Protection for Retirement Plans

For many of us, retirement plans are a very significant asset. It is estimated that over $15 trillion are held in ERISA and IRA plans. ERISA-qualified retirement plans (like 401k plans) are fully protected from creditors under federal law. Some non-qualified plans, including IRAs, are protected at least partially under state law (more on that below). IRAs that are inherited (i.e., the plan participant has died) are not protected, which is a big missing piece in the asset protection planning of most people.

ERISA provides protection from creditors for all qualified plan assets while they remain inside the plan. ERISA protection is retained even when assets are distributed to the plan participant from a pension plan, but is lost when assets are distributed from a welfare benefit plan. A "pension" plan is defined as any "plan, fund or program which...provides retirement income to employees." This definition includes 401k plans, many defined benefit and profit sharing plans.

N.B. Once assets are distributed from a retirement plan, they will enjoy protection under California law, so long as the amount distributed is reasonably necessary to cover the participant's and family's basic living expenses, and so long as the distributions are segregated from other monies (keep in a separate bank account).

ERISA protection extends to all plan assets, regardless of how or when contributed to the plan, so long as the contribution is allowed within the ERISA guidelines (i.e., the plan is not over-funded, etc.).

IRAs (regardless of their prefix), are not governed by ERISA and do not enjoy ERISA protection. IRA protection varies from state to state. They are fully protected in Florida, but are partially protected in California.

California provides (similar to the Bankruptcy Code) that IRAs are protected only to the extent the funds in the IRA are reasonably necessary to provide for the plan participant's (and his family's) retirement needs, but in no event to exceed $1 million.

To determine what is "reasonably necessary" the courts will look at the participant's age and other funds available for retirement. This standard is applied very strictly, and not in a manner that favors the plan participant. Most everyone reading this newsletter does not have an IRA that is protected under this standard. One exception is an IRA that is a rollover from an ERISA-qualified plan. It retains the protection of the qualified plan.

IRAs are usually protected from creditors by rolling them over into an ERISA-qualified plan.

All retirement plans are protected (fully or partially) because either Congress or state legislators considered it important to safeguard retirement benefits of plan participants and their spouses. Protection for heirs and beneficiaries was never contemplated. Consequently, courts in many states have held that the protections available for IRAs do not extend to inherited IRAs. Courts in Alabama, California, Florida, Illinois, Texas, and Wisconsin have all ruled that inherited IRAs have no asset protection, whether in or out of bankruptcy.

One way to protect inherited IRAs is to name a special retirement trust as the IRA beneficiary. Commonly these trusts are used to stretch out the required minimum distributions, but they can also be drafted to provide asset protection to trust beneficiaries.