Why You Need to Protect Your Retirement Savings
Some people spend their entire adult lives saving up for retirement, only to lose everything to a lawsuit or a creditor.
To many of our clients, this sounds like a far-fetched possibility, particularly if you haven’t done anything unethical or deserving of a lawsuit. But in a society as litigious as the United States, and with as deeply entrenched of a victim-oriented culture as the United States, unjust lawsuits do happen, and they are often more successful than we would hope.
Some professions are particularly at risk, including doctors, business owners, real estate agents, and lawyers (yes, even us). If you belong to one of these professions, you’re probably aware of the risks of losing your assets and the importance of asset protection.
Realistically, though, anyone is at risk for a lawsuit. Here are just a few ways lawsuits can affect ordinary people:
- If you are at fault in a car accident (and everyone makes mistakes on the road, so this could happen to you), the other party might sue for amounts that far exceed your insurance limits.
- If you are a dog owner, you might face a similarly expensive dog bite lawsuit. This is particularly a risk in California, where pet owners face “strict liability,” which means they are responsible for their pets no matter what, even if there is no past history of aggression.
- If you own a business, one of your employees might be injured on the job, or a customer can slip and fall, and demand compensation.
The list goes on and on. Damages in these sorts of cases may include potentially huge amounts in nebulous and poorly quantifiable “noneconomic damages” such as pain and suffering.
And we haven’t even gotten into other ways you might lose your assets, such as debt collection and bankruptcy.
It gets worse for those of us who live in California: the laws of our state are particularly hostile to debtors, with relatively low caps for the homestead and life insurance exemptions. California also has a fairly strict fraudulent transfer law, and a much longer statute of limitations for fraudulent transfer than most other states, going up to seven years in some circumstances.
However, in spite of all this, there is one glimmer of light for Californians. You see, California law offers citizens of our state a unique way to protect your assets: the Private Retirement Plan (PRP).
What Is a Private Retirement Plan?
The Private Retirement Plan is a financial instrument which allows you to protect your assets, not just from plaintiffs who have sued you but also from debt collectors. The assets within a PRP are even protected in bankruptcy.
This protection is codified into California law, in the California Code of Civil Procedure §704.115. This provision is not new; it has been part of our state law since 1982. And has been well-tested in the courts. This means that there is significant case law behind the PRP, and you will be standing on strong footing if you decide to set up such a plan.
PRPs must be created by an employer for their employees. The actual creation of a PRP involves setting up a private retirement trust like a pension, which is administrated by a third party.
PRPs have a plethora of advantages looking to protect their assets:
- They are effectively tax-neutral, and you do not need to file the PRP with the IRS annually.
- These plans are very flexible: you are not required to cover all employees and the amount contributed for retirement depends on the individual’s income and lifestyle.
- PRPs do not have to meet the standard of ERISA-qualified plans in order for your assets to be protected.
- Assets placed within the plan will not just be protected while they are within the plan, but even after they are withdrawn or transferred to an IRA or other retirement plan.
When a Private Retirement Plan Doesn’t Work
Does a PRP sound too good to be true?
Well, it is and it isn’t. Private retirement plans can work spectacularly for asset protection if you know what you are doing.
But as you might have guessed, the politicians who wrote the law allowing for PRPs weren’t going to make things too easy for you, and there are limits on what these plans can and cannot do.
A private retirement plan is not a cure-all, and certain practices must be adhered to. If they are not, then the private retirement plan will not work.
The PRP will not protect your assets when:
- You leave California. Although it may seem too obvious to mention, California Code of Civil Procedure §704.115 is a state law and it only applies when you actually live in California. If you move out of state, then you will lose the asset protection benefits of a PRP.
- You use the plan for purposes other than retirement. As mandated by law, the PRP must be used primarily for retirement purposes. Thus, it has to be something which was created in good faith to actually be a retirement plan. You can’t just stick the term “private retirement plan” over any amount of assets and assume they will be protected. For instance, you can’t place your personal residence within the plan, because such property is clearly not intended as retirement savings.
- Contributions must be related to your actual retirement needs. The amount must be at least somewhat related to your actual retirement needs.
- You commit a fraudulent transfer. Fraudulent transfer occurs when someone moves money in order to avoid paying a debt. Your PRP, just like any other instrument of asset protection, will become vulnerable if it can be shown that you were insolvent when you made the transfers of money into it or if you did so with the intent of evading creditors. Transfers to a PRP must be made well in advance of a lawsuit or debt arising.
- Your plan was not created by your employer. A private retirement plan must be created by an employer for their employees. If you create a private retirement plan on your own, without any employer involvement, it will not be sufficient.
Remember, if your plan fails under even one of these criteria, then it will not protect your assets. Each of these conditions are necessary but not sufficient for a successful PRP.
As Tolstoy might have said, successful PRPs are (almost) all alike, but each unsuccessful PRP is unsuccessful in its own way.
It is also important to note that in the event of a divorce, a private retirement plan (like other property obtained during the marriage) will generally, absent an agreement to the contrary, be considered community property.
Recent Retirement Plan Related Case Law
California Code of Civil Procedure §704.115 permits private retirement plans, but it does not go into great depth about how these plans actually work. Therefore, it has fallen to the courts to work out issues surrounding the PRP, and most of the law regarding PRPs is case law.
Over the years, judicial rulings in various cases have firmly established the asset protection benefits of the PRP. However, the limitations of these plans have also been well-established, and a few recent cases help display some of the limits of a PRP.
A pair of 2011 bankruptcy cases further illustrate the limits of PRPs.
In the case In re Chen, the debtors claimed exemption for multiple retirement plans under California’s PRP law, but their claims were denied on the basis that California laws regarding PRPs only applies to plans created by employers and not to those created by individuals.
In the case In re Beverly, the court found that a man who transferred a significant amount of funds to his wife in anticipation of declaring bankruptcy in the near future, in exchange for a comparable share of exempt retirement funds, had committed a fraudulent transfer.
Together, these cases serve as a reminder that PRPs are not inviolate, and that if you break the rules laid out by the courts for these plans, or engage in a fraudulent transfer, you will lose all protection.
In the 2015 case Salameh v. Tarsadia Hotel, a motion for attorney’s fees was filed against the plaintiffs in the case, whose lawsuit had been dismissed with prejudice. One of the plaintiffs, Dale Curtis, attempted to claim exemption for the money within a private retirement plan shared by himself and his wife Michele.
The court rejected this claim of exemption, noting that although the Curtises were unable to provide any evidence that their PRP had been designed and used for retirement purposes. Specifically, they failed to show evidence such as bank statements and other records of account activity which would give the court an idea of how the funds within the plan were used.
This is a particularly interesting case, because it shows that if you wish to claim exemption for some of your assets that are held within a PRP, the burden of proof will be on you to provide evidence of this to the court. They will not take your word, and the default assumption absent evidence to the contrary will be that your plan is not protected, no matter what your intentions may have been.
In the 2013 divorce case Marriage of LaMoure, Nathan LaMoure argued that the money within his pension plan should be exempted from the division of assets with his ex-wife. His argument rested on California Code of Civil Procedure §704.115 as well as the Employee Retirement Income Security Act of 1974.
The trial court rejected his motion, and an appellate court upheld this judgment, finding that “there was substantial evidence that Nathan abused the pension plan by secreting community property assets and funneling… them through the pension plan.”
This case demonstrates some of the limitations of PRPs in the event of a divorce settlement. Of course, the relevance of this limitation to your situation will depend greatly on the stability of your marriage.
So, How Good Are Private Retirement Plans, Exactly?
PRPs have been at the center of a lot of hype in recent years.
Many attorneys and financial planners have sold these as a magical asset protection strategy which completely eliminates your need to take further steps.
This may help some people sell as many PRPs as possible, but we believe it’s better to be realistic about what PRPs can and cannot do. As we’ve laid out in this article, these plans must be used properly to work for their intended purpose. They are not magical solutions, and they do not erase your need to take other steps to protect your assets.
Don’t get us wrong: PRPs can be extremely useful. We are simply saying that if you want to protect your assets to the greatest degree possible, you shouldn’t rely on a PRP alone.
It’s great that those of us who live in California have this particular option at our disposal, but the best asset protection plans are always comprehensive, and the more comprehensive, the better. For maximum efficacy, a PRP should not stand alone, but should be used in conjunction with a number of other legal instruments intended for the same purpose.
In any case, asset protection will involve a good deal of careful thought and planning on your part, and it is worth speaking to an attorney today so that you know exactly what you are doing when you set out to protect your estate from greedy creditors.