Tax and ERISA Issues of California Private Retirement Plans
CAPRP_Tax_ERISA CAPRP CaprpERISAAndTaxIssues
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:
- Qualified Plans, which are both tax-qualified and ERISA-qualified
- Non-Qualified Plans, which are neither tax-qualified nor ERISA-qualified
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:
- Contributions to the plan are determined without regard to tax limitations;
- Plan investments are more flexible because they are not subject to tax or ERISA limitations;
- It is unnecessary to include other employees in the plan; and
- There are no penalties for withdrawal under age 59½ and no requirement for distribution to begin at age 70½.
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.
Tax and ERISA Issues of California Private Retirement Plans Topics And Opinions
California Private Retirement Plan Topics And Opinions -- All Pages
- California Code of Civil Procedure 704.115
- California Private Retirement Plan Defects
- Gluck v. Sarkissian, 2021 WL 5407188 (Cal.App., 2nd Distr., Unpublished, Nov. 19, 2021).
- In re Barnes, 275 B.R. 889 (Bk.E.D.Cal., 2002).
- In re Beverly, 374 B.R. 221 (9th Cir., B.A.P., 2011).
- In re Bloom, 839 F.2d 1376 (9th Cir., 1988).
- In re Chen, 2011 WL 2358653 (Bk.N.D.Cal., 2011).
- In re Crosby, 162 B.R. 276 (Bk.C.D.Cal., 1993).
- In re Daniel, 771 F.2d 1352 (9th Cir., 1985).
- In re Davis, 323 B.R. 732 (BAP 9th Cir., 2005).
- In re Friedman, 220 B.R. 670 (9th Cir.B.A.P., 1998).
- In re Lieberman, 245 F.3d 1090 (9th Cir., 2001).
- In re Phillips, 206 B.R. 196 (Bk.N.D.Cal., 1997).
- 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 Stern, 345 F.3d 1036 (9th Cir., 2003).
- In re Switzer, 146 B.R. 1 (Bk.C.D.Cal., 1992).
- Marriage of La Moure, 221 Cal.App.4th 1463, 15 Cal.Rptr. 3d 417 (2013).
- McMullen v. Haycock, 147 Cal.App.4th 753, 54 Cal.Rptr. 3d 660 (2007).
- O'Brien v AMBS Diagnostics, LLC, 38 Cal.App.5th 553, 251 Cal.Rptr.3d 41 (Aug. 8, 2019).
- Post-Distribution Exemption-Tracing Issues of California Private Retirement Plan
- Salameh v. Tarsadia Hotel, 2015 WL 6028927 (S.D.Cal., 2015).
- Schwartzman v. Wilshinsky, 50 Cal.App.4th 619, 57 Cal.Rptr.2d 790 (1996).
- Voidable Transactions And California Private Retirement Plans
- Yaesu Electronics Corp. v. Tamura, 28 Cal.App.4th 8, 33 Cal.Rptr.2d 283 (1994).