ERISA and Tax Issues Of California Private Retirement Plans
California Private Retirement Plans can be very complex insofar as they frequently implicate ERISA and tax issues which overlap, interweave, intertwine, show their ugly head at the worst time, and in general drive planners totally bonkers.
California Private Retirement Plans can usually be divided into two categories:
These categories will be discussed below. Suffice it to say that what constitutes a "tax-qualifed plan" or an "ERISA-qualified plan" involves a very complex and lengthy analysis that is far beyond the scope of this website. These topics will thus herein be discussed only to the extent that they directly implicate creditor issues.
In general, a tax-qualified plan is one that qualifies for pre-tax treatment, i.e., the employer makes tax-favored contributions to the plan, the employee is not taxed on the contributions, the plan assets are not subject to taxation while they are in the plan, the employee cannot withdraw from the plan without penalty before age 59½, and distributions from the plan must commence at age 70½. Tax-qualified plans include both ERISA plans (described below) and non-ERISA plans, the latter primarily being certain self-employed retirement accounts and IRAs.
An ERISA-qualified plan (or more simply called an "ERISA plan") is one that meets the criteria of the Employee Retirement Income Security Act of 1974, including, among other things, that the plan cover all employees. ERISA plans can further be parsed into defined contribution plans, whereby a funding target is set, and defined benefit plans, which set a target benefit to be paid to the employee upon retirement. Typical varieties of ERISA plans include: 401(k) plans, ESOPs, stock ownership plans, and profit sharing plans.
The assets of ERISA plans are normally protected while they are in the plan by the so-called ERISA Anti-Alienation Provisions of 29 U.S.C. § 1056(d)(1). However, ERISA plans are not immune from fraudulent transfer actions, and the ERISA Anti-Alienation provisions do not protect assets from the employee's creditor after they have left the plan, i.e., they become fair game for creditors, at least under ERISA.
California law at CCP § 704.115(a) provides an additional layer of protection for ERISA assets, i.e., the ERISA Anti-Alienation Provisions and § 704.115(a) run side-by-side to protect the assets in ERISA plans. However, California law goes one step further, and also protects the plan distributions after they have been made to the employee, under the "tracing statute" of CCP § 703.080.
However, § 704.115(a) does not give complete protection to all tax-qualified plans, but only ERISA plans. Non-ERISA plans such as self-employed retirement plans and IRAs are not fully exempt automatically, but instead are subject to the Means Test of § 704.115(e), which basically requires the court to determine how much money the debtor will need upon retirement. The balance of the plan is then available to creditors, less the amount of state and federal taxes (including any penalty if the debtor is not yet 59½) that will by owed by the debtor for taxes on that money. [While the situation of each debtor under this test will of course vary widely based on age, needs, etc., a rough "rule of thumb" used by some creditors is that amounts under $500,000 are likely to be protected, while amounts over $500,000 will be difficult for the debtor to protect. But the court opinions on this subject are all over the board, utterly lack anything approaching consistency, and a disinterested observer could come to the quite reasonable conclusion that the courts are coming up with amounts under the Means Test based on some combination of looking at tea leaves, rubbing chicken bones together, throwing dice, and the liberal use of a OUIJA board.]
The downside to tax-qualified plans is that there are strict tax law limits on contributions to such plans and that the tax-qualification (and thus the exemption) could be lost due to some technical error. While ERISA plans certainly offer the highest degree of protection because of the additional protection of the Anti-Alienation provisions, such plans require the inclusion of other employees. Nonetheless, the "best practice" is to max-out the tax-qualified and ERISA plans before looking at planning with Non-Qualified Plans, as will next be discussed.
Section 704.115(a) also protects Non-Qualified Plans. Non-Qualified Private Retirement Plans have lately become popular because of four benefits:
Qualified Plans and Non-Qualified Plans are not mutually exclusive; it is entirely possible for an employee to have both. However, if an employee has both a Qualified Plan and a Non-Qualified Plan, particular attention must be paid to the retirement needs of the employee, since the amounts needed for the Non-Qualified Plan will be reduced by the amounts to be paid under the Qualified Plan, i.e., that both a Qualified Plan and a Non-Qualified Plan are allowed does not mean that the employee can seek to fund retirement far in excess of his anticipated needs.
There are at least two downsides to Non-Qualified Plans. The first is that they are exclusively post-tax plans, i.e., there is no deduction for contributions to the plan, and income to the plan is taxable to the employee.
The second downside is that, because Non-Qualified Plans are not required to follow the IRS guidelines for Qualified Plans, there are no benchmarks that tell the court what is reasonable, i.e., reasonable contributions, reasonable distributions, reasonable use of assets, etc., and thus such plans are potentially more subject to a successful challenge by creditors unless set up and administered conservatively. Here, the old adage "pigs get fat, hogs get slaughtered" should always be respected. Suffice it to say that if a Non-Qualified Plan gets too far away from what would be allowed in a Qualified Plan, the Plan becomes particularly susceptible to a court declaring that the Plan has been misused to defeat creditors, and the exemption lost.
Pigs get fat, hogs get slaughtered. Live by that here.
TEXT OF CCP § 704.115
California Code of Civil Procedure § 704.115.
(a) As used in this section, “private retirement plan” means:
(1) Private retirement plans, including, but not limited to, union retirement plans.
(2) Profit-sharing plans designed and used for retirement purposes.
(3) Self-employed retirement plans and individual retirement annuities or accounts provided for in the Internal Revenue Code of 1986, as amended, including individual retirement accounts qualified under Section 408 or 408A of that code, to the extent the amounts held in the plans, annuities, or accounts do not exceed the maximum amounts exempt from federal income taxation under that code.
(b) All amounts held, controlled, or in process of distribution by a private retirement plan, for the payment of benefits as an annuity, pension, retirement allowance, disability payment, or death benefit from a private retirement plan are exempt.
(c) Notwithstanding subdivision (b), where an amount described in subdivision (b) becomes payable to a person and is sought to be applied to the satisfaction of a judgment for child, family, or spousal support against that person:
(1) Except as provided in paragraph (2), the amount is exempt only to the extent that the court determines under subdivision (c) of Section 703.070.
(2) If the amount sought to be applied to the satisfaction of the judgment is payable periodically, the amount payable is subject to an earnings assignment order for support as defined in Section 706.011 or any other applicable enforcement procedure, but the amount to be withheld pursuant to the assignment order or other procedure shall not exceed the amount permitted to be withheld on an earnings withholding order for support under Section 706.052.
(d) After payment, the amounts described in subdivision (b) and all contributions and interest thereon returned to any member of a private retirement plan are exempt.
(e) Notwithstanding subdivisions (b) and (d), except as provided in subdivision (f), the amounts described in paragraph (3) of subdivision (a) are exempt only to the extent necessary to provide for the support of the judgment debtor when the judgment debtor retires and for the support of the spouse and dependents of the judgment debtor, taking into account all resources that are likely to be available for the support of the judgment debtor when the judgment debtor retires. In determining the amount to be exempt under this subdivision, the court shall allow the judgment debtor such additional amount as is necessary to pay any federal and state income taxes payable as a result of the applying of an amount described in paragraph (3) of subdivision (a) to the satisfaction of the money judgment.
(f) Where the amounts described in paragraph (3) of subdivision (a) are payable periodically, the amount of the periodic payment that may be applied to the satisfaction of a money judgment is the amount that may be withheld from a like amount of earnings under Chapter 5 (commencing with Section 706.010) (Wage Garnishment Law). To the extent a lump-sum distribution from an individual retirement account is treated differently from a periodic distribution under this subdivision, any lump-sum distribution from an account qualified under Section 408A of the Internal Revenue Code shall be treated the same as a lump-sum distribution from an account qualified under Section 408 of the Internal Revenue Code for purposes of determining whether any of that payment may be applied to the satisfaction of a money judgment.
COURT OPINIONS RE CALIFORNIA PRIVATE RETIREMENT PLANS
In re Daniel, 771 F.2d 1352 (9th Cir., 1985).
In re Bloom, 839 F.2d 1376 (9th Cir., 1988).
In re Crosby, 162 B.R. 276 (Bk.C.D.Cal., 1993).
Yaesu Electronics Corp. v. Tamura, 28 Cal.App.4th 8, 33 Cal.Rptr.2d 283 (1994).
Schwartzman v. Wilshinsky, 50 Cal.App.4th 619, 57 Cal.Rptr.2d 790 (1996).
In re Friedman, 220 B.R. 670 (9th Cir.B.A.P., 1998).
In re Phillips, 206 B.R. 196 (Bk.N.D.Cal., 1997).
In re Stern, 345 F.3d 1036 (9th Cir., 2003).
McMullen v. Haycock, 147 Cal.App.4th 753, 54 Cal.Rptr. 3d 660 (2007).
In re Rucker, 570 F.3d 1155 (9th Cir., 2009).
In re Segovia, 404 B.R. 896 (2009).
In re Simpson, 557 F.3d 1010 (2009).
In re Beverly, 374 B.R. 221 (9th Cir., B.A.P., 2011).
Marriage of La Moure, 221 Cal.App.4th 1463, 15 Cal.Rptr.3d 417 (2013).
Salameh v. Tarsadia Hotel, 2015 WL 6028927 (S.D.Cal., 2015).
Only published court opinions are included; non-published opinions are not useful as legal precedent and should not be relied upon.
ARTICLES ON CALIFORNIA PRIVATE RETIREMENT PLANS
The California Private Retirement Plan: Separating Fact From Fiction (Jay Adkisson, Forbes.com, Dec. 28, 2015)
MAIN SECTIONS OF THIS WEBSITE
Leading Court Opinions and Legislative History of CCP § 704.115
The published court opinions, both state and federal, and the legislative history of CCP § 704.115 give valuable insight into how California private retirement plans should be properly structured and used. See Court Opinions and Legislative History
Voidable Transactions Issues (formerly: Fraudulent Transfers)
As amply demonstrated by the case law, the law of voidable transactions (formerly: fraudulent transfers) has frequently and successfully been used by creditors to avoid transfers made to California Private Retirement Plans. Please see our Voidable Transactions page for more.
Plan Defect Issues
Creditors have frequently been successful in busting California Private Retirement Plans because either (1) there was no real "plan", or (2) the plan was not substantially followed by the debtor. Read more on our Plan Defect Issues page.
ERISA, Tax-Qualified Plans and Non-Tax Qualified Plans
Considers the types of private retirement plans as measured by ERISA and tax law, including ERISA-qualified plans, tax-qualified plans, and non-qualified plans. Read more on our ERISA and Tax Issues page.
Post-Distribution Exemption-Tracing Issues
Considers the application of the exemption tracing statute, CCP § 703.080, to California Private Retirement Plans. Please visit our Post-Distribution Exemption-Tracing Issues page.
Services & Contact Information
Jay Adkisson assists clients in creating California Private Retirement Plans in appropriate circumstances, and reviews existing plans for their defensibility against creditor challenges. Jay is also involved with litigation in attacking PRPs from the creditor's side, and defending them from the debtor's side. Please see our Services & Contact Information page.
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