California’s new law reduces protections for tax-qualified retirement plans, such as 401(k)s and profit-sharing plans, and allows California debtors to move to another state where all retirement plans are fully forgiven. It will have such an impact that there is a possibility that it will be considered.
Debtors who wish to remain in the Golden State may wish to move the affected plan’s liquid assets into a self-directed individual retirement account and move those assets offshore.
California law, like the Employee Retirement Income Security Act, fully exempts a debtor’s assets under a tax-qualified retirement plan from creditor claims. The state also completely waives creditor claims if distributions from these plans are deposited into segregated bank accounts.
Federal law does not provide a similar exemption for distributions. Prior to the enactment of this new state law, California debtors were required to ensure that assets in a tax-qualified plan were protected under federal and California law during the plan and under California law with respect to distribution. I felt relieved knowing that.
California protections do not apply to individual retirement accounts (including Roth and SEP IRAs). IRAs are only partially exempt in California, which uses a means test that examines what assets the debtor has outside of his retirement plan and how much time the debtor has until retirement. are. If a plan participant has significant assets outside of the IRA or has many years left until retirement, the IRA is not exempt under California law.
The new law amends California Code of Civil Procedure Section 704.115 to apply the IRA means test to tax-qualified retirement plans beginning January 1, 2025. This means 401(k) and other tax-qualified plans are no longer exempt. without limits. A judge will now decide how much of the retirement allowance is needed for living expenses and how much can be handed over to creditors. This would reduce the amount of wealth that would be safe from seizure by creditors.
Fortunately, federal law limits the application of California’s new law. Under ERISA, funds in ERISA-qualified plans have no dollar limits and, with some exceptions, are exempt from claims against plan participants. Because both laws address the same subject matter, federal law supersedes California law and federal protections are maintained.
Federal law does not apply to distributions made under a plan. This means that, beginning January 1, 2025, the assets of California residents who participate in ERISA-qualified retirement plans will continue to be fully exempt while remaining in the plan and only partially exempt with respect to distributions. It means to be done. The current unlimited exemption will disappear.
This new law will disrupt the asset protection advice we provide to our clients. We previously advised clients in California to rollover their IRAs into ERISA-qualified plans. Although this may still be a good option for clients who are not taking distributions or are not approaching age 73 (where plan participants must begin taking required minimum distributions) , does not work for other clients.
Debtors or anyone concerned about asset protection should immediately consult an attorney about how best to protect distributions from an ERISA-qualified plan. This is especially important for people for whom planning accounts for a significant portion of their wealth. California law has evolved to be very creditor-friendly, and the IRA averages test applied to distributions from ERISA plans will likely not exempt many distributions.
California debtors concerned about reduced retirement plan protections may consider two options. Some debtors may leave California for states that offer full forgiveness of retirement plan assets. Some people may be able to roll over liquid assets from a tax-qualified plan into a self-directed IRA.
A self-directed IRA allows plan participants a broader range of investment options, including investing in plan assets outside the United States. It may be more difficult for creditors to recover on assets held in other countries.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Jacob Stein is an asset protection attorney and global chairman of Alliant’s private client practice, focused on protecting assets from creditor claims.
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