California State Capitol in Sacramento.
getty
On September 24, 2024, the Governor of California signed into law AB 2837, which made certain changes to the California Judgment Enforcement Law (known as “EJL”). Most of these changes are related to consumer and medical debt, which I don’t usually address, so I’ll let someone else comment on these changes. However, there are also changes to CCP § 704.115 that are very interesting as they relate to tax-qualified retirement plans. These changes will become effective on January 1, 2025. Please note that these changes do not apply to retirement plans that are not tax qualified. Again, not applicable.
Prior to AB 2837, most tax-qualified retirement plans were completely exempt from enforcement of creditor judgments. Additionally, distributions from these tax-qualified retirement plans were similarly exempt from enforcement of creditor judgments. This means that if the debtor has funds in a tax-qualified retirement plan, creditors cannot get their hands on those funds, and creditors also cannot get their hands on those funds once they are distributed. This means that you cannot enter it.
Partially exempt from this protection prior to AB 2837 were individual retirement accounts (IRAs – including Roth IRAs) and certain simplified employee pension (SEP) plans. These IRAs and SEPs were subject to the so-called means test of § 704.115(e) and therefore had only partial protection (if any).
The means test asked debtors and their dependents how much money they needed to live in retirement. This sounds very good at first glance, but the problem is that the means test also looks at all of the debtor’s other income and assets to determine what this amount should be. Therefore, if the debtor had not only an IRA but also a company-sponsored retirement plan, none of the IRAs may be protected because the company-sponsored retirement plan will take care of the debtor’s retirement needs. It becomes more sexual. Alternatively, if the debtor is under age 60 and could theoretically supplement that amount with income until retirement, the SEP or IRA is not protected.
As a side note, due to the high cost of living in California, the amount that California courts will protect for a debtor’s retirement funds is often limited, even if the debtor has no other source of retirement income. It’s unreasonably low. Court opinions vary widely, but suffice it to say that my own rule of thumb is that the amount protected typically does not exceed $250,000. This may be a lot of money for someone living in rural Arkansas, but for someone living in a metropolitan area or along the coast of California, it’s not an amount that will last you for 25 years. That’s about 95% of California’s population.
What AB 2837 did was apply the means test in § 704.115(e) to all tax-qualified retirement plans. Therefore, tax-qualified retirement plans that were previously fully protected will no longer be fully protected. Instead, California courts will now also consider these plans to determine how much money a debtor will need in retirement. This is a very significant negative change for California debtors with such plans.
But wait a minute! These tax-eligible accounts, which are currently means-tested, are most often ERISA plans, and ERISA anti-alienation provisions prevent creditors from enforcing judgments against money while it is held in an ERISA plan. It works to prevent. ERISA, a federal law, governs state laws to the contrary, including EJL. Therefore, your money is safe within your ERISA plan as long as it is in your ERISA plan.
The problem arises when there are distributions to the debtor from the ERISA plan. ERISA may protect funds within an ERISA plan, but not the funds after they are distributed. Therefore, these funds are fair game for creditors under state law.
This is the biggest change in AB 2837. Previously, distributions from ERISA plans were exempt from enforcement of creditor judgments under § 704.115(b). Since AB 2837, these ERISA plan distributions are still exempt from creditors, but they are not fully protected. Instead, the same mean test analysis in § 704.115(e) now also applies to ERISA plan distributions. In other words, almost minimal protection for funds held in an ERISA plan.
What this means is that debtors with dischargeable debt and who have accumulated large amounts of money in tax-qualified retirement plans should consider bankruptcy as an option. Bankruptcy may provide greater protection for tax-qualified retirement plan assets than is available under California law. Additionally, bankruptcy can drain creditors before distributions from an ERISA plan can be made. However, I often warn that bankruptcy is the most dangerous place for debtors with assets and that you should think twice before pulling the trigger on bankruptcy, with the help of an experienced bankruptcy attorney. Please be careful.
The faint silver lining to all this is that AB 2837 extends one protection to tax-qualified plans that are no longer fully exempt. Federal and state taxes resulting from the distribution are added and reduce the amount creditors receive. Accordingly. This is true for IRAs and SEPs, and now for all tax-qualified plans.
Yes, it’s done. California residents who had tax-qualified plans would go to bed on New Year’s Eve knowing that their tax-qualified plans were fully protected from creditors, but they would wake up on New Year’s Day to find out that their tax-qualified plans were completely protected from creditors. The plan is almost never followed.
What this means for California asset protection planning is that tax-qualified retirement accounts of any type are now highly susceptible to creditor attacks. What remains protected in California are tax-free retirement accounts. Asset protection planners must now take that into consideration in their planning and stop assuming that tax-qualified plans will protect California residents.
