• Using Private Retirement Plans to Safeguard Assets Against Creditors.
  • December 1, 2010
  • Law Firm: Law Office of Dennis A. Fordham - Lakeport Office
  • I. INTRODUCTION

                Asset protection, retirement planning and estate planning are becoming increasingly interwoven.  Clients seek not only to transfer wealth to their beneficiaries with the least possible amount of taxes, time and aggravation, but also want to ensure that their assets will be protected against their creditors for themselves and their death beneficiaries.  Thus, estate planning attorneys now often advise their clients about asset protection. For those clients with sufficient liquid assets to transfer abroad ¿ and still retain enough assets domestically to not run afoul of the “law of fraudulent transfers” ¿ offshore asset protection usually offers the most effective solution.  But, given that off-shore asset protection is for a select few who have over $1 million in liquid assets available to transfer offshore, what so-called domestic (on-shore) asset protection options are available to our other clients?  

                Domestic asset protection begins with the state statutory exemptions available in the client’s state of residence.  While California law offers few major opportunities, the statutory exemption for “Private Retirement Plans” found in the California Code of Civil Procedure section 704.115[1] is an important planning opportunity.  Section 704.115 is a statutory safe harbor that protects private retirement plan assets against creditors; as a statutory safe harbor it is impregnable by creditors.  Private retirement plan funds are absolutely protected against creditor claims and distributions from these funds after reaching the plan’s retirement age are likewise protected.  Also protected (but not protected to the same degree) are Individual Retirement Accounts (hereafter “IRA’s”) and Self Employment Plans. These assets, however, are only protected to the extent necessary for support of the participant and his family during retirement.

                Private retirement plans include plans that are not qualified under ERISA, as well as ERISA qualified plans.  Non qualified plans do not have to meet the Internal Revenue Code requirements related to ERISA qualified plans, such as the annual limits on employee contributions and employee participation requirements.  Non qualified plans, therefore, can supplement the participant’s ERISA qualified plan, which enjoys absolute creditor protection to provide a more secure retirement. II.

                  In order to be exempt, private retirement plans must be designed and used primarily for retirement purposes.  A plan does not, however, need to be exclusively used for retirement purposes.   Courts have applied a totality of the facts and circumstances analysis and used many different factors to determine whether the plan was both designed and administered primarily for retirement purposes.  Understanding the case law is critical to determining what withdrawals and loans to the participant are allowed prior to retirement.  It is also important in understanding whether the plan is designed and used primarily for legitimate retirement purposes as opposed to creditor avoidance purposes.

      STATUTORY BACKGROUND TO SECTION 704.115

    A. Purpose and Nature of Private Retirement Plans

                Section 704.115 is part of Chapter 3, exemptions to enforcement of creditor claims.  As an exemption statute it is, “¿ to be liberally construed for the benefit of the debtor.”[2]    

                Section 704.115 applies to all situations where a judgment creditor seeks money from a judgment debtor.[3]  As such, the exemption applies to both bankruptcy and non bankruptcy situations.  In bankruptcy proceedings, the purpose of the section 704.115 exemption “is to safeguard a stream of income for retirees at the expense of bankruptcy creditors.”[4]  The intended retirement purpose is, therefore, the threshold issue in determining whether the exemption applies.

    B.        Legislative History behind section 704.115(a)[5]

    The creditor protection afforded in section 704.115, subdivision (a) to private retirement plans derives from the precursor section 690.18.  Section 690.18 was amended in 1970 to include an exemption for “private retirement plans” and “profit sharing plans”.  Previously, the Code of Civil Procedure only protected the retirement plans of public employees.  The 1970 amendment extended equal protection to private employees.  In 1976, the Legislature amended section 690.18 to add “self employed retirement plans” and “individual retirement annuities” (traditional, “IRA’s”).  Then in 1976, the Legislature amended section 690.18 to curtail the creditor protection extended to IRA’s by limiting what is protected in the IRA’s to the maximum allowed amounts exempt from federal income taxation.

                In 1982, present section 704.115, subdivision (a) was created when the Legislature divided the prior section 690.18 into two separate sections:  Section 704.110 (public retirement benefits) and section 704.115 (private retirement benefits).

                C.        The Definition of Private Retirement Plan

    Paragraph (a) of section 704.115 defines “private retirement plan” purposes of the exemption as follows:

    (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 1986,1 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. 

    It is far preferable to qualify as a private retirement plan under section 704.115, subdivision (a)(1) rather than as a self employed retirement plan under section 704.115, subdivision (a)(3).  Self employment plans and IRA’s are much less protected than private retirement plans and profit sharing plans.  Private retirement plans and profit sharing plans are absolutely protected (except for certain child, family or spousal support debt payments).

    III. CREDITOR EXEMPTION ALLOWED TO PRIVATE RETIREMENT PLANS

    A. Private Retirement Plans under section 704.115(a)(1)

    1. Absolute  Protection

          The protection afforded to a private non qualified retirement plan, prior to distribution, is virtually absolute.  Before distributions are made from a private retirement plan, paragraph (b) of section 704.115 provides the following relevant protection:

    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 (emphasis added).[6]

    Once distributions are made to the participant, section 704.115, subdivision (d) provides absolute protection to both the contributions by the participant and the earned interest received by the participant, as follows:


    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 (emphasis added).[7] 

    2. Exceptions for Child, Family and Spousal Support obligations 

                Creditor protection under section 704.155 is not complete protection, however, because child, family or spousal support judgments may still be satisfied.[8]  In certain circumstances, however, support orders may still be applied against private retirement plans when an amount becomes payable to a participant who owes child, family or spousal support.[9] 

     

    B. Self Employed Retirement Plans and IRA’s 

    1. Contributions made to self employed retirement plans and IRA’s

     

    a. Limited Protection for contributions held inside self employed retirement plan or IRA

                Self employment plans and IRA’s, are much less protected from creditor claims.  Section 704.115(e) allows the exemption to self employed retirement plans and IRA’s:

    a. only to the extent necessary 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 (emphasis added[PJ1] ). 

    b. Debtor has burden of proof to show financial need and inability to rebuild 

    The debtor has the burden of proof to show the extent to which the exemption applies.[10]  The extent to which the IRA or plan assets meet the foregoing test depends on the following factors:                

    &smbull; The debtor’s present need for the money; and

    &smbull; The [debtor’s] ability to rebuild the retirement fund if purged.[11]

     

    The facts will be established at a debtor’s examination where the creditors question the debtor.  The debtor must provide financial statements showing income, assets, expenses and debts related to the support needs of himself, his spouse and his dependents; including proof as to present and future health care expenses.  The debtor needs to show that the retirement account is necessary to support the debtor, the debtor’s spouse and dependents; and that the debtor is not likely to be able to replace the assets if taken. 


                In Black Schwartzman v. Stephen Wilshinsky (hereafter In re Schwartzman), a forty (40) year old stock-broker, owed a judgment of $1,750,000.[12]  He earned over $475,000 per year and owned substantial assets.[13] The court denied the exemption to the IRA, reasoning that:

     

    [$1,750,000] is a daunting sum ¿ but it cannot be determined from that fact alone that the appellant will not have the resources to support himself and his dependents in his retirement. ¿ It can reasonably be inferred from appellant’s impressive earnings power that appellant will be able to do so, and appellant failed to meet his burden to provide enough evidence to avoid that inference.[14]


     

    c. Protection allowed for periodic distributions

     

    Periodic payments from IRA’s and retirement plans that are not exempt may still be substantially protected because paragraph (f) of section 704.115 provides, as relevant, that:

    ¿ 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).
     
                Where the debtor requires substantially all of the periodic payment to meet his current expenses, then the debtor may be able to protect up to seventy-five percent of each periodic payment.[15]

     

    2. Rollover contributions into IRA’s from Private Retirement Plans

     

    Following the Ninth Circuit’s ruling In re Schwartzman[16] that, “[t]he exemption statutes should be construed, so far a practicable, to the benefit of the judgment debtor,”[17] the Los Angeles County Superior Court in McMullen v. Haycock,[18] allowed for rollover contributions from private retirement plans into IRA’s to be traced back to the original private retirement plan because:

     

    ¿, the mere transfer of the fully exempt private retirement plan assets to the IRA did not necessarily eliminate their full exemption under 704.115, subdivisions (b) and (d).[19]

     

    Tracing adds complexity. Any client wishing to roll over their private retirement plan into an IRA is well advised to establish a separate IRA solely for the rollover and not to contribute any further earnings into such account.

     

    C. Bankruptcy protections for Private Retirement Plan

     

    1. The Bankruptcy Estate

     

    a. Exceptions for Spendthrift Trusts and ERISA plans

     

    Federal bankruptcy law excepts (excludes) Spendthrift Trusts and ERISA Qualified Retirement Plans from inclusion in the debtor’s bankruptcy estate.[20]  Private retirement plans ordinarily include a spendthrift clause preventing creditor attachment of the plan’s assets.  The spendthrift clause excludes the retirement plan assets from the bankruptcy estate.[21]  

     

    In California, the spendthrift clause in a private retirement plan alone protects between seventy-five and one-hundred percent of plan distributions.[22]  This would not apply to a self-settled (self-employment) retirement plan as California law voids any spendthrift clause that protects the settlor’s interests in the trust assets.[23]

     

    b. Bankruptcy Exemption for Individual Retirement Accounts

               

    Federal Bankruptcy law exempts just over $1 million in assets (excluding rollover contributions)[24] held inside an IRA ¿ regular or Roth IRA’s ¿ unless not authorized by the law of the state where the bankruptcy petition is filed.[25]  Unfortunately, California law does not authorize the federal exemptions for bankruptcy provisions.[26]  California bankruptcy petitioners must, therefore, choose either to follow California’s non bankruptcy exemptions (listed in sections 704.010 through 706.154) or to follow the so-called Cal-Fed Exemptions found under section 703.140(b).[27]

     

    Federal protection exceeds the protection given to IRA’s generally under California law, which protects IRA’s “only to the extent necessary for support”.[28]  Unless the bankrupt debtor has very little additional earning power left and has few other resources with which to support the debtor, the debtor’s spouse and the debtor’s dependents in retirement, the generous $1 million dollar bankruptcy exemption almost always protects more of the debtor’s IRA account(s).  Where appropriate, a debtor with large IRA’s might consider filing bankruptcy in another state that allows the use of the federal bankruptcy exemptions; provided that proper venue can be established in such state.

     

    Notwithstanding the general rule, some IRA’s are either fully or partially exempt against creditor claims.  To the extent that IRA assets can be traced back to a rollover from a private retirement plan that portion of the IRA itself is exempt from creditors as though it were an employer established private retirement plan described under subparagraph (a)(1) of section 704.115.[29]  Naturally, clients considering a rollover from their employer’s private retirement plan are well advised not to commingle their private retirement plan rollover funds inside an IRA with other contributory funds; open a new IRA account just for the rollover.

     

    2. Converting Assets into Exempt Assets Prior to Bankruptcy

     

    It is a well established rule in bankruptcy that the bankruptcy petition filing date determines what assets qualify as exempt.[30]  Converting non exempt assets into exempt assets is not fraudulent per se.[31] A debtor may convert non exempt assets into exempt assets on the eve of bankruptcy.[32]  A debtor in bankruptcy can, therefore, transfer assets from an IRA account into a private retirement plan or profit sharing plan prior to filing bankruptcy and enjoy the absolute protections afforded private retirement plans.

     

    In Gill v. Stern (hereafter In re Stern)[33] the debtor, Steven H. Stern, transferred the proceeds of his IRA into his employer’s profit sharing plan immediately prior to filing his bankruptcy petition.  This transfer occurred after the Los Angeles Superior Court issued Mr. Stern a writ of attachment to secure an arbitration award of over 4.5 million dollars.  The Trustee sought to undo the transfer from the IRA as a fraudulent conveyance.[34]  The Ninth Circuit, however, agreed with Mr. Stern that he was entitled to protect his retirement assets by transferring them into the profit sharing plan, reasoning that:

     

    [w]ith the exception of the arbitration loss and the speculative insolvency, the other articulated badges of fraud are simply restatements of the accusation that Stern converted nonexempt assets into exempt assets, an accusation that cannot support a finding of fraud.[35]

     

    IV.  REQUIREMENTS TO BE A PRIVATE RETIREMENT PLAN

                The obvious unhelpfulness of the circular definition of “private retirement plans” as including “private retirement plans” has been recognized by federal and state courts.[36]  Federal and state court decisions provide to the missing content to the definition of “private retirement plan” in subparagraph (a)(1) of section 704.115.  The following discussion examines what is necessary for a plan to be exempt under section 704.115.

    A.    Plan Documents

    1.      A formal written plan should be used

                In Charles Philips v. Kevin C. Mayer (hereafter In re Philips)[37] the United States District Court rejected an informal retirement plan involving funds set aside for retirement purpose, because:

    ¿ there is no concrete evidence of this [retirement] intent. Their ‘informal retirement plan’ was never reduced to writing and funds were used for a variety of purposes, non-related directly to retirement.[38]

    A formal retirement plan document governing the private retirement plan is a necessary starting point to demonstrating a genuine retirement purpose.  The plan document itself could be a trust agreement written to allow a trustee to hold and control retirement funds for retirement purposes with non retirement uses being very limited, if not totally prohibited.[39] 

    One approach to drafting private retirement plan documents is to begin with a qualified plan document (such as a pension plan), remove the federal tax code restrictions relevant to tax deferral, and add at death administrative provisions to govern the disposition of the remaining assets at the participant’s death, such as found in a living trust.[40]  Using a tax qualified retirement plan as a template will provide you with the necessary provisions related to loans to the participant and to hardship withdrawals by the participant from the plan prior to reaching the retirement age.  The end result is a plan document with the substance of a genuine retirement plan.

    2.      When the plan is executed

    When the retirement plan document is executed is important.  That is, the formal retirement plan document certainly be executed before a creditor judgment is issued, and preferably even before the creditor’s lawsuit commences.  Otherwise, the debtor risks the court finding that the debtor’s true intention in establishing the retirement plan is principally creditor avoidance. 

    In re Philips[41] the debtors executed the documents to establish the retirement plan soon after learning about the judgment against them.  The court opined that,

    [g]iven these facts, and the previous actions of appellants discussed above, the bankruptcy court inferred that appellants were attempting to shield their assets from creditors rather than enhance their retirement needs.[42]

     

    B.      Judicially Imposed Requirements

    1. Designed and Used Principally for Retirement Purposes

    The threshold legal question, that the courts ask to determine if the private retirement plan exemption applies, is whether the plan is “designed and used for retirement purposes”.[43]  In Howard Douglas Daniel v. Security Pacific National Bank (hereafter In re Daniel)[44] the Ninth Circuit loosened the foregoing limitation to require that the plan only be “designed and used principally for retirement purposes”.[45]  The definition tolerates dual purposes in a plan that is principally designed and used for retirement purposes; otherwise legitimate retirement plans would lose their protection due to secondary non retirement purposes.

    2.      Applies to each type of Private Retirement Plan

    In regards to “profit-sharing” plans, subparagraph (a)(2) of section 704.115 expressly states the “designed and used for retirement purposes” limitation.  Case law, however, has extended this limitation to “private retirement plans” exempt under subparagraph (a)(1) and also to “self employed retirement plans and IRA’s exempt under subparagraph (a)(3). 

    In Edith Bloom v. Gilbert Robinson (hereafter In re Bloom)[46] the Ninth Circuit extended the “designed and used primarily for retirement” requirement to “private retirement plans” because, “[w]ithout regard to its label, a plan not used and designed for retirement purposes is not a retirement plan.”[47] 

    Next, in Dudley(hereafter v. Anderson In re Dudley)[48] the Ninth Circuit extended the “designed and used” requirement to “self employed retirement plans and IRA’s” exempt under paragraph (a)(3) because:

    [a]s with a private retirement plan under section 704.115(a)(1), the phrase “designed and used for retirement purposes” is implicit in the term “individual retirement annuities or accounts” as used in  704.115(a)(3). See H.R.Rep. No. 94-455, at page 346 (1976) reprinted in 1976 U.S.C.C.A.N. 2897, 3242 (“IRA's are supposed to be used for retirement purposes.”)[49]

    C.     The Totality of the Circumstances Test

                 No one single factor is essential to whether a private retirement plan is designed and used principally for retirement purposes.[50]  “[A]ll factors are relevant; but no one is dispositive.”[51]  The following are the factors that courts have examined in their total “facts and circumstances” analysis. 

    1.      Subjective Intent

    The plan participant’s subjective intent ¿ purpose ¿ may affect whether or not the asset is exempt.  In Bruce Howard Simpson v. Michael F. Burkart (hereafter In re Simpson)[52] the Ninth Circuit opined that, “while the debtor’s subjective intent cannot create an exemption, it may take one away (emphasis added).”[53]  Why? Lack of subjective intent to use the funds for retirement purposes itself indicates that the plan was not truly designed and used for retirement purposes. 

    a.      Subjective Intent alone cannot make an asset exempt

    It is not sufficient for someone to simply claim that an asset is intended for retirement purposes.[54]  In Lieberman v. Hawkins,[55] the Liebermans claimed that a ten year stream of income was exempt as a private retirement plan, “¿ because it was designed and used to support her and her husband in their retirement”.[56]  The Ninth Circuit rejected the Liebermans’ argument because:

    [i]f [the legislature] intended to exempt assets that debtors simply declare to be intended for retirement (as Debtors have done) it could have said so without reference to ‘plans.’ It could have simply declared as exempt all assets a debtor intends to use for retirement [57].

    b.      Establishing the subjective intent of the plan participant

                How the plan participant uses any borrowed money may itself establish his or her subjective intent. In Re Daniel,[58] the debtor borrowed $75,000 from his so-called private retirement plan and used it to buy a residence.  The Court reasoned that if the debtor’s subjective intent was to use the plan for his retirement, then, “¿ he would surely have invested the funds in assets which would yield a competitive money market return, would provide adequate security, and would preserve and enhance the capital of the plan.”[59]  Similarly, in Segovia v. Schoenmann,[60] the United States District court rejected a claim for exemption where the debtor repeatedly used her retirement plan benefits to remodel her home, instead of saving for her retirement. [61]

                Also, the debtor’s own testimony can show intent.  In Yaesu Electronics Corporation v. Yukio Tamura (hereafter In re Yaesu Electronics Corporation)[62] the debtor “¿ admitted that he had never had a retirement plan.  He conceded that his purpose in establishing the YMT Plan was not to save money to use in his retirement but to take advantage of the tax laws and to save money for his children”.[63] 

    2.      Using Retirement Plans Primarily to Hide and Conceal Assets

    Private retirement plans can obviously become very tempting places for distressed debtors to hide and shield their assets from their creditors.  In the Matter of Lloyd Myles Rucker (hereafter In re Rucker)[64] the Ninth Circuit recently considered, “... whether a person who funds a retirement plan for retirement purposes in part and to shelter assets and avoid paying debts in part has acted primarily for retirement purposes.”[65]  In that case, Mr. Rucker owed $3.2 million in civil judgments related to fraud awarded in 1997.  Using his wholly owned corporations, Mr. Rucker in 2001 established a pension and several 401(k) plans, which he overfunded.  Mr. Rucker did not, however, take any loans or withdrawals from the plan, a point that was central in Mr.  Rucker’s defense.[66]

    In re Rucker, the Ninth Circuit’s reiterated its position In re Dudley that, “[a] plan used in part to shield assets is still exempt if it was designed and used primarily for retirement purposes.”[67]  The Court, however, rejected Mr. Rucker’s claim for exemption because it was convinced by Mr. Rucker’s “egregious and deceptive conduct in funding the plan” to conclude that, “¿Rucker’s Plans were designed and used primarily to shield assets.”[68]  Also, “Mr. Rucker’s expressed goal of shielding his assets from Cunning [was] yet another factor suggesting that his Plans were not used primarily for retirement purposes.[69]

    3.      Accumulation of Assets inside Plan

    May non retirement assets be immediately transferred into a private retirement plan or must they be accumulated from earnings gradually inside the private retirement plan? 

    With regards to private retirement plans under section 704.115(a)(1), it is clear that such plans must receive employee contributions gradually over time and not all at once.  In Re James and Carol Barnes (hereafter In re Barnes)[70] the United States District court stated:

    ¿the court must consider the use of the word “plan” in section 704.115(a)(1). A plan requires more than the instantaneous transmutation of a lump sum of previously nonexempt money or other assets into an exempt retirement plan. It contemplates the gradual accumulation of money to fund a future retirement (emphasis added).[71]

    The same gradual accumulation of assets is likewise required with regards to self employed retirement plans under section 704.115(a)(3).  In re Barnes the court also opined:

    Whether one is considering a Keogh plan, a 401(k) plan, a simplified employee pension, or an IRA, these tax qualified plans share one feature in common. They provide for the gradual accumulation of a finite amount of pretax annual income in a tax qualified account in order to fund a taxpayer's future retirement.[72]

    4.      Control and Administration of the Plan

                Control and administration of a private retirement plan or profit sharing retirement plan by the plan participant is relevant for two reasons: 

    &smbull; May the debtor exercise total control over contributions, management, over a private retirement plan; and

    &smbull; If so, can the plan only qualify as a self employment plan under paragraph (a)(3) of section 704.115. 

                In Re Schwartzman,[73] Mr. Wilshinsky contributed to his employer’s profit sharing 401(K) plan, which was administered by a committee composed of certain employees, appointed by the board of directors.  Mr. Wilshinsky did not have the authority to manage the plan or to disregard the plan rules.[74]  The appeals court, therefore, found no impermissible control by Mr. Wilshinsky because, “¿ appellant took no loans or disbursements; ¿ did not contribute more than he was entitled; and he had no part in administering the plan.”[75]

                Presumably then, had Mr. Wilshinsky been the sole employee in charge of administering the plan and used his position of authority to take loans or disbursements for himself and/or otherwise to receive more benefits than he was entitled to receive, then such control over the retirement plan would have evidenced an obvious non-retirement purpose on his part and likely disqualified the plan from being exempt. 

    5.      Are plans controlled by the participant limited to self employed plans?

                Can a plan owned by a corporation that is wholly owned and controlled by one person nonetheless qualify as a private retirement plan under either section 704.115(a)(1) [private retirement  plans] or 704.115(a)(2) [profit sharing retirement plans]?  Or, is the plan limited to section 704.115(a)(3) [self employed retirement plans and individual retirement annuities or accounts]?  The answer depends on whether the private retirement plan is owned by a closely held corporation or is owned directly by the individual owner/participant himself. 

    In Ceferino G. Cheng v. David Gill[76] the United States Ninth Circuit confronted that very issue.  Dr. Cheng was the sole shareholder, director and chief executive officer of a medical corporation that established and maintained two retirement benefit plans under his total control.  The Ninth Circuit held that the plan nonetheless qualified as a private retirement plan under section 704.115(a)(1) because:

     

    [a]lthough the legislative history indicates that the policy behind section 704.115(e) is to limit the exemption for plans that are controlled by one person, the statute says what it says ¿  .  If the California legislature intended to treat closely held corporations differently than large corporations, it could have done so explicitly.[77]

     

    Interestingly, in 1996 the California Court of Appeal on decision of In re Schwartzman cites to the Ninth Circuit decision, In re Cheng, as an example of the “kind of control which would show a non retirement purpose” and prevent exemption,[78] even though the Ninth Circuit did not find Dr. Cheng’s total control over his private retirement an issue.  Perhaps the court that decided In re Schwartzman would have found that Dr. Cheng’s private retirement plan served a nonretirement purpose because it was controlled by the employee participant in his capacity as director and chief executive officer of his closely held corporation.

     

                That an entrepreneur can effectively control and administer his own creditor exempt private retirement plan through his own closely held business entity is a major planning opportunity.  If the same individual is unable to establish an ERISA qualified plan, which is fully creditor protected, then a non qualified private retirement plan established by his or her own business entity is a viable alternative.

     

    6. Withdrawals and Loans from the Plan Prior to Retirement

     

    Often crucial to the whether the plan is “designed and used” for a retirement is whether [and, if so, on what terms] are  distributions from the plan to the participant before he or she reaches the plan’s specified retirement age are allowed, and how such distributions are handled in actuality.  Such distributions are either withdrawals or loans to the participant. 

    a.      Withdrawals prior to reaching retirement age

    Some withdrawals by the participant will not prevent the plan qualifying as a retirement plan so long as the plan’s primary purpose is retirement.  

    In re Dudley, the Ninth Circuit Court recognized that a rigid and absolute standard would defeat the purpose of the section 704.115 exemption.  In the underlying bankruptcy case, the bankruptcy court had denied the exemption to a couple that had withdrawn approximately $107,000 from an IRA to pay living expenses.[79]

           The Ninth Circuit reversed the bankruptcy court for the following reasons:

    The fact that a debtor has withdrawn or will withdraw sums from an IRA for non-retirement purposes does not automatically disqualify the debtor from claiming the amount remaining in the IRA as exempt under § 704.115(a)(3). “If the primary purpose is to provide income for a debtor in retirement, the assets in the plan should be exempt under § 704.115. Otherwise, even a de minimis depletion of the plan assets would destroy the exemption, which would be contrary to the purpose of the exemption statute to preserve income for retirees.[80].

                So what is a de minimis depletion?  As the [PJ2] $107,000 depletion was not per se too high, it appears that de minimis must be relative to the overall size of the given plan.

     

    Furthermore, if a hardship withdrawal is made prior to retirement with an obligation to repay the withdrawal, then the court is likely to believe that the participant intended to replenish the funds at a later date.[81]

     

    b. Loans prior to retirement

     

                Next, in regards to borrowing by the participant, legitimate loans are unlikely to be found abusive.  In re Bloom, even though the participant loaned more than half of her interest in the profit sharing plan to herself, the Ninth Circuit held, “¿ that Bloom’s plans were not so abused as to lose their retirement plan.”[82]  In re Bloom, the Court created and applied the following four prong fact and circumstance analysis, as follows:

     

    First, Bloom followed the procedures set out in the Trust Agreement for obtaining loans.  Second, Bloom was charged a reasonable rate of interest on the loans. Third, she regularly made the interest payments due, over a period of years.  These three factors indicate that, unlike the debtor in Daniel, these transactions were not ‘more a withdrawal than a loan.’  [citation omitted]  Fourth, there is no indication that Bloom used the plan to hide otherwise ineligible assets from bankruptcy administration, as did the debtor in Daniel.  In sum we recognize that Bloom did not cease to treat her plans as retirement plans.[83]

     

    c.         Illegitimate Loans reveal the plan was not for retirement purposes

     

                On the other hand, In re Daniel, the Ninth Circuit found that an ERISA qualified plan was not exempt, even though the plan “may have been originally designed for retirement purposes”,[84] because it was not used for retirement purposes.  In re Daniel, the debtor managed and controlled the plan; the debtor had great borrowing powers which he used to borrow $75,000 to buy a home, which he did not secure with a deed of trust; the debtor did not pay the $75,000 note when it became, but simply replaced it with another note; and, lastly, two weeks prior to filing for bankruptcy the debtor contributed $39,000 to the plan (nearly all the corporation’s remaining cash) in violation of ERISA, as it was not based on any profit calculation even though the plan purported to be an ERISA qualified plan. [85]          The Ninth Circuit found such borrowing from the plan was abusive and was more like a withdrawal than a loan[86] because:

     

    ¿ the plan essentially operated to meet the debtor’s short term personal needs by lending money or shielding and hiding funds from creditors.  Moreover the debtor ¿ failed to show how [the] transactions ¿ were in furtherance of legitimate long-term retirement purposes (emphasis added).[87]


     

    d.         Distributions made during retirement

     

    Once the participant has reached the plan’s specified retirement age, distributions to the participant from the private retirement plan can be made and the money used for any purpose without any negative consequences. After reaching retirement age, any use of retirement distributions has no effect on whether the plan was “being used for retirement.”  The participant may even become re employed during retirement and receive his retirement distributions while reemployed.  What matters is that the employee attained the plan’s retirement age before receiving retirement distributions. 

     

    In re Cisneros v. Kim,[88] a Los Angeles Metropolitan Transit Authority (“MTA”) bus driver resumed working for the MTA after he retired and began receiving plan distributions.  The bankruptcy court found the plan exempt because:

    [t]he Retirement Plan was clearly designed for retirement purposes, because it limited the ability of participants to recover contributions prior to retirement and required participants to work twenty-three years in order to receive full benefits. It does not allow the participants free access or control over their funds in the Retirement Plan until retirement (emphasis added).[89]

     

    IV        CONCLUSION

                Private retirement plans are an opportunity for employed persons who either do not have access to an ERISA qualified plan or who wish to save more for retirement than ERISA allows them to contribute to their ERISA qualified plan.  Private retirement plans, are not, however, for those wishing to hide assets from their creditors or devices to be used primarily for non retirement living expenses.  Self employed persons should consider doing business in entity form and have their business entity create the private retirement plan as a non qualified plan exempt from creditors under section 704.115(a)(1). 

                Whether a plan is designed and used primarily for retirement purposes is determined a total facts and circumstances analysis that will vary from case to case.  Attorneys drafting and implementing such private retirement plans should make sure that the formal plan document is designed and used primarily for retirement purposes.  This requires an understanding of all the factors courts examine in applying the total facts and circumstances analysis.

                Clients transferring assets from a private retirement plan (qualified or not qualified) into an IRA should not commingle the funds transferred with other earnings. The IRA will then be fully exempt as if it were a private retirement plan. 

                Clients considering filing bankruptcy should try to transfer as much of their IRA retirement assets into their employer’s private retirement plan, as legally possible, prior to filing the bankruptcy petition, in order to receive complete creditor protection.  Clients with large IRA’s may wish to consider the feasibility of filing in another state that authorizes the federal bankruptcy exemptions, in order to obtain the generous $1 million federal exemption for IRA’s.

    * Lakeport, California



    [1] All further statutory references are to the California Code of Civil Procedure unless otherwise indicated.

    [2] Blake Schwartzman v. Stephen Wilshinsky (hereafter In re Schwartzman) 50 Cal App 4th 619 (2nd District, Div. Three, Oct. 30, 1996).

    [3] Max R. Moses v. Southern California Permanente Medical Group, (hereafter In re Moses) 167 F.3d 470, 476 (9th Cir. 1999)

    [4] DeMassa v. MacIntyre, 74 F.3d 186, 188, (9th Cir. 1996)

    [5] Lieberman v. Hawkin (hereafter In re Lieberman) 245 F.3d 1090, 1093-1095 (Ct. App. 9, 2001)

    [6] Code of Civil Procedure, section 704.115., subdivision (b)

    [7] Code of Civil Procedure, section 704.115, subdivision (d)

    [8] Code of Civil Procedure, section 704.115, subdivision (c).

    [9] A creditor would need to make a motion under Code Civil Procedure section 7063.070.

    [10] Code of Civil Procedure, section 703.580, subdivision (b).

    [11] In re Charles William Spenler, 212 B.R. 625, 631 (9th Cir. BAP. 1997); In re Cosby, 162 B.R.276, 285 (Bankr. C.D. Cal. 1993).

    [12] Schwartzman, supra, 50 Cal App 4th 619, 625-627.

    [13] Ibid.

    [14] Id. at page 627.

    [15] Code of Civil Procedure, section 706.110.

    [16] In re Schwartzman, supra, 50 Cal App 4th 619

    [17] In re Schwartzman, supra, 50 Cal App 4th 619, 630.

    [18] McMullen v. Haycock, 147 Cal. App. 4th 753 (2007).

    [19] Id. at page 756.

    [20] Section 541(c)(7) Bankruptcy Code, Paterson v. Shumate 504 US 758 (1992); In re Moses, supra, 167 F3d 47

    [21] Ibid.

     

    [22] Probate Code, section 15306.5(b).

    [23] Probate Code, section 15304.

    [24] 11 USC sections 522(d)(10)(E) and 522(n).

    [25] 11 USC section 522(b)(2).

    [26] Code of Civil Procedure, section 703.130.

    [27] 11 USC 522(b)(1).

    [28] Code of Civil Procedure, section 704.115, subdivision (d).

    [29] Gill v Stern (hereafter In re Stern), 345 F3d 1036 (9th Cir. 2003), cert denied (2004) 541 US 936.

    [30] Love v. A.S. Mesnick (hereafter In re Love), 341 F.2d 680, 682 (9th Cir. 1965).

    [31] Wudrick v. Clements (hereafter In re Wudrick), 451 F.2d 988 (9th Cir. 1971), see also In re Jackson 472 F.2d 589, 590 (9th Cir. 1973).

    [32] Howard Douglas Daniel v. Security Pacific Bank (hereafter In re Daniel), 771 F.2d 1352, 1358 (9th Cir.1985) cf In re Love, supra, 341 F.2d 680, 682.

    [33] In re Stern  supra, 345 F3d 1036, cert denied (2004) 541 US 936.

    [34] Id. at pages 1041-1042.

    [35] See In re Wudrick, supra, 451 F.2d 988, 1045.

    [36] cf In re Lieberman, supra, 245 F.3d 1090, 1093-1095:  “As other courts have recognized, the intent of the California legislature in enacting § 704.115(a)(1) is not clear from the face of the statute. See In re Rogers, 222 B.R. 348, 351 (Bankr.S.D.Cal. 1998) (‘Code Civ. Proc. § 704.115(a)(1) is vague and undefined.’); In re Phillips, 206 B.R. 196, 200 (Bankr.N.D.Cal. 1997) (stating that § 704.115(a)(1) ‘curiously and unhelpfully defines ‘private retirement plan’ as a ‘Private retirement plan’); id. at page 202 (‘[T]he California Legislature has not defined a ‘private retirement plan’ as the term is used in Section 704.115 in any meaningful way.’).”

    [37] Charles Philips v. Kevin C. Mayer  (hereafter In re Phillips), 218 B.R. 520, 523 (USDC, ND California, 1988)

    [38] Id. at page 523.

    [39] In re Phillips, supra, 218 B.R. 520, 523

    [40] Continuing Education of the Bar, Continuing Legal Education, “Domestic Asset Protection Planning” (April 2007)

    [41] In re Phillips, supra, 218 B.R. 520, 523.

    [42] Id. at page 523.

    [43] Yaesu Electronics Corp. v. Tamura (hereafter In re Yaesu), 28 Cal. App. 4th 8, 14 (1994).

    [44] In re Daniel, supra, 771 F.2d 1352, 1353-1354.

    [45] Id. at pages 1357-58.

    [46] Edith Bloom v. Gilbert Robinson (In re Bloom), 893 F.2d 1376 (9th Cir. 1988).

    [47] Id. at page 1378.  

    [48] Dudley v. Anderson (hereafter In re Dudley), 249 F.3d 1170 (9th Cir. 2001).

    [49] Id. at page 1176.

    [50] In re Bloom, 839 F.2d 1376, 1379 (9th Cir. 1988); In Matter of Lloyd Myles Rucker (In re Rucker), 570 F.3d 1155 (9th Cir. 2009).

    [51] Ibid.

    [52] Bruce Howard Simpson v. Michael F. Burkart (hereafter In re In re Simpson), 557 F.3d 1010 (9th Cir. 2009).

    [53] Id. at pages 1017-18.

    [54] In re Lieberman, 245 F.3d 1090 (Ct. App. 9th Cir. 2001); see In re Rogers, 222 B.R. 348, 351 (Bankr. S.D.Cal. 1998), opining that paragraph (a)(1) of section 704.115, “does not extend to protect anything a debtor unilaterally chooses to claim as intended for retirement purposes.”; and see also In re James and Carol Barnes (hereafter In re Barnes) 275 B.R. 889, 897 (Bankr. ED Cal. 2002).

    [55] In re Lieberman, supra, 245 F.3d 1090, 1093-1095.

    [56] Id. at page 1092.

    [57] Id. at page 1095.

    [58] In re Daniel, supra, 771 F.2d 1352, 1358

    [59] Id. at page 1375.

    [60] Segovia v. Schoenmann (In re Segovia), 404 B.R. 896 (ND Cal. 2009.).

    [61] Id. at page 912.

    [62] In re Yaesu Electronics Corporation, supra, 28 Cal. App. 4th 8, 14.

    [63] Id. at page 14.

    [64] In re Rucker, supra, 570 F.3d 1155, 1159.

    [65] Ibid.

    [66] In re Rucker, supra, 570 F.3d 1155, 1160.

    [67] Id. at page 1176, citing from In re Dudley, supra, 249 F.3d 1170.

    [68] Id. at page 1161.

    [69] Id. at page 1159, referring to In re Simpson, supra, 557 F.3d 1010, 1018 (9th Cir. 2009).

    [70] In re Barnes, supra, 275 B.R. 889 .

    [71] Id. at page 896.

    [72] Id. at page 898.

    [73] In re Schwartzman, supra, 50 Cal App 4th 619 (2nd District, Div. Three, Oct. 30, 1996).

    [74] Id. at page 628.

    [75] Ibid.

    [76] In re Ceferino G. Cheng v. David Gill, 943 F2d 1114 (9th Cir. 1991).

    [77] Id. at page 1117.

    [78] In re Schwartzman, supra, , 50 Cal App 4th 619, 629.

    [79] In re Dudley, supra, 249 F.3d 1170, 1173.

    [80] Id. at page 1176.

    [81] See In re Marriage of Susan and Darby Calwell, WL 1383618 at page 5 (Cal. App. Dist. 4, 5/18/2009)

    [82] In re Bloom, supra, 893 F.2d 1376, 1379.

    [83] In re Bloom, supra, 893 F.2d 1376, 1379. 

    [84] In re Daniel, supra, 771 F.2d 1352, 1353-1358.

    [85] Id. at pages 1352-1357.

    [86] Id. at page 1352.

    [87] Id. at page 1358.

    [88] In re Cisneros v. Kim, 257 BR 680 (BAP9 Cal. 2000).

    [89] Id. at page 683.


     [PJ1]Need to check rule on this. Before or after the quote CF

     [PJ2] perhaps it does not like "that a" - change to "that the”  ?