Qualified plans such as 401(k)s, profit sharing plans and traditional defined benefit plans are protected under federal law under Employee Retirement Income Security Act (ERISA). Protection continues for all qualified plan assets as long as the assets remain inside the plan and there are non-owner employees participating in the plan.
ERISA protection extends to all plan assets without regard to when or how contributions are made to the plan so long as the contributions are permitted within the ERISA guidelines. For example, protection is not afforded on over-funded plans with contributions in excess of the ERISA guidelines. ERISA protection is very strong.
In the Guidry case, a union representative stole money from the union and contributed the funds to his 401(k) plan. The union sought to recover the stolen or embezzled funds and when the theft was discovered, the representative was critically prosecuted. The representative was convicted and sentenced to 37 months in prison. Nevertheless, the court refused to impose a constructive trust over the funds. The case went all the way to the U.S. Supreme Court which held that only the plan participants can withdraw or take the funds out of an ERISA or qualified plan. That is very significant protection.
Individual Retirement Accounts (IRA’s) are not governed by ERISA and do not receive similar protection. IRA protection is based upon state law. As a result, IRA protection varies from state to state.
IRA’s are fully protected in Florida. However, California only provides limited or partial protection. California provides that IRA’s are protected only to the extent that the funds within the IRA are “reasonably necessary” to provide for the plan participants retirement needs.
In determining what is “reasonably necessary”, the court will look at the participant’s age and other funds available for retirement. This standard is applied or constituted in a narrow manner which does not favor the plan participant. Few IRA’s will qualify under this standard.
The biggest exception in an IRA is a rollover from an ERISA qualified plan. The IRA rollover will retain the substituted protection of the qualified plan. An IRA can obtain greater protection from lawsuits and creditors by rolling it over into an ERISA qualified plan.
Inherited IRA’s are not entitled to any meaningful protection from lawsuits or creditors. The U.S. Supreme Court ruled on June 12, 2014, in Clark v. Rameker that inherited IRA’s did not qualify as a retirement account and did not qualify for protection. The U.S. Supreme Court determined that retirement accounts are protected under federal or state laws to safeguard and protect retirement benefits for the plan participants or their spouses. Protection for heirs and beneficiaries was not intended, as an inherited IRA was not truly intended as a retirement account or fund for the original plan participant.
Protection from lawsuits, creditors and divorce can be achieved by using the IRA Inheritance Trust as an IRA beneficiary. The IRA Inheritance Trust is also often used to “stretch out” or defer income that may be incurred. Income tax deferral can result in substantial tax savings.
This is particularly true today because the income tax “stretch out” can result in substantial growth and increase in value. Today, it is perhaps the first time in our history that many of us worry that our kids will be less successful than ourselves. Tax rates are higher than we endured and everything is more expensive. Many of the corporate retirement or defined benefit plans are gone and no longer offered. All of this makes planning for inherited IRA’s even more important than ever before.
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