Private Retirement Plan

Many people believe that the only kind of pension plan one can have is what is known as a qualified pension plan; i.e., pension which could consist of a money purchase or defined benefit, profit sharing, 401k, IRA, or any other tax-deductible retirement plan. Many of these plans are asset protected with regard to creditors and even, in some cases, bankruptcy; however, not everybody has the opportunity to be in a qualified retirement plan. If one resides in California, there is hope.

California Code of Civil Procedure Section 704.115 affords a complete exemption for the assets of a “private retirement plan” (PRP). There is hope in the definition of a PRP through case law that has developed in California. Essentially, the definition of a PRP under Cal. Code of Civ. Proc. Sec. 704.115(a) is extremely simplistic: exempt plans include union retirement plans; profit-sharing plans “designed and used for” retirement; and plans qualifying under the federal tax code (e.g. IRAs/SEPs/etc.).  Said another way a plan managed by a trustee or custodian and meant to provide retirement benefits to a privately-employed individual. Thus, a California business owner can set up a retirement plan of which the funding will be paid by the company into the trust and held for the business owner’s retirement. The key here is that the funds stay in the plan and while they are in the plan they are exempt from the business owner’s creditors. Interestingly, even when the funds are distributed from the plan, they will remain protected from the business owner’s creditors under other California laws as long as they are kept separate and not comingled with other funds.

To date it appears that the California courts have concentrated on the word “plan”. In order for the plan to work, it must be a comprehensive plan for retirement purposes. Therefore, simply depositing money into one’s account will not work. However, if there are plan documents, a schedule or formula of payments which must be paid into the plan, a trustee or custodian holding the money pursuant to the documents, a schedule or formula of payments which will be made from the plan upon the business owner’s retirement, and some other miscellaneous requirements the California courts seem to have allowed the exemption.

While the money is in the plan it can be invested but not returned to the business owner by way of loans or any other subterfuge. There is no limit on how much money can be contributed as long as the money is contributed according to the set schedule or formula and bears an actuarial relationship as to how much and when money will be paid for retirement.

As with any retirement plan, the purpose of installing a PRP is to help someone who is not eligible for a qualified plan for the purpose of retirement, be able to put away as much money as possible for their retirement planning. An ancillary benefit, like a qualified plan, is the protection from creditors while the money resides in the plan and even when it comes out as discussed previously.

It is possible to create a tax-qualified PRP and thus create a tax deduction for the contributions to the plan. There may be limitations as to how much money may be protected if the plan is to be structured as a qualified tax-deductible plan. Other restrictions with regard to a qualified plan include:

(1)   The plan cannot distribute prior to age 59½ without penalty;

(2)  Required minimum distributions will need to begin at age 70½; and

(3)  The plan may have to include other employees and thus not discriminate.

On the other hand, if a deduction is not critical, then the above restrictions can be eliminated by creating a non-qualified PRP. A non-qualified PRP can operate in conjunction with a qualified plan regardless of whether the qualified plan is a PRP or not. There are some interesting tax planning strategies with regard to distributions and the fact that payments from the non-qualified plan at retirement may be made as a lump-sum as opposed to annuitizing or can even be withdrawn as tax-free loans as long as this occurs during the retirement phase.

There is still uncertainty within the statutory law regarding PRPs and thus it is critical to have an attorney familiar with this structure draft the plan documents, including arranging for any actuarial calculations that may be required. A PRP can be an effective and cost beneficial method of creating a discriminatory retirement plan with the side effects of protecting the assets from creditors under well-established California law.