Thoughts on AB 2837: The California Private Retirement Plan – A Shiny Shield in Shifting Sands

Thoughts on AB 2837: The California Private Retirement Plan – A Shiny Shield in Shifting Sands

This article is the author’s current opinion in an area of law that is always changing and complex; it may not be relied upon as legal advice.

Not all retirement plans are created equal.

When people think about asset protection, they are often thinking about two very different risks:

• Creditor or lawsuit exposure in California courts (exposure to judgment creditors); and

• Exposure in bankruptcy under federal law (federal law nevertheless applies in California bankruptcy even though California has “opted out” of the list of property that federal law dictates is exempt from the bankruptcy estate).

This distinction is critical – because the manner in which your retirement accounts are treated (the level of creditor exposure) varies depending on whether you are facing a non-bankruptcy creditor (i.e., a judgment creditor who won a lawsuit against you) or a bankruptcy creditor (i.e., a lender or other person or entity to whom you owe money). 

For purposes of this article, we are focusing on one type of asset: retirement plans. In the California estate planning, California asset protection, and California bankruptcy world, retirement plans are often said to be one of two types of plans: an ERISA plan or a non-ERISA plan (“ERISA” refers to the Employee Retirement and Income Security Act of 1974). But understanding the asset protection nature and character of a retirement plan is not that simple – I wish it was. Retirement plans may have certain tax characteristics – California estate planning attorneys and tax attorneys also refer to retirement plans as being tax-qualified or non-tax-qualified (as does the IRS). And we also have the SECURE Act – that complex law governs when and how often distributions from certain qualified retirement plans must begin.

We are homing in on the question of whether a particular retirement plan is an ERISA-qualified plan – and the level of creditor exposure that results after California’s new AB 2837 (effective January 1, 2025), depending on whether a non-ERISA-governed plan nevertheless may be defined as a California private retirement plan or profit-sharing plan. The other aspects of retirement plans can be addressed in future articles or via a phone call to an experienced California estate planning attorney.

AB 2837 changes how certain retirement accounts are protected from creditors in California non-bankruptcy court – a judgment enforcement proceeding, for example. Once a plaintiff obtains against the defendant a verdict, order, or perhaps a default judgment (if the plaintiff does not respond to the lawsuit, a judgment that the plaintiff has prevailed “by default” often is entered against the defendant), by virtue of a judgment, the plaintiff becomes a judgment creditor: the plaintiff will record in the county in which the plaintiff wishes to execute or levy against the defendant’s property an abstract of the judgment and follow some rather complex (though not to experienced creditor’s attorneys and judgment enforcement attorneys) writ and levy procedures. Whether the judgment creditor can indeed levy the defendant’s property and collect the value of the property (via judicial foreclosure, for instance) depends on the type of the property and whether the property is “exempt” under the part of the California Code of Civil Procedure that exempts from judgment creditors certain property. (California’s Enforcement of Judgments Law is located at Section 680.010 et seq. of the Code of Civil Procedure.) For instance, current California law affords homeowners a decent amount of defense against judgment creditors and bankruptcy: around $700,000 of home equity in a California primary residence is protected (though the exact value depends on the county in which the primary residence is located and the year in which the lawsuit or bankruptcy is filed).

California Code of Civil Procedure Section 704.115(b) provides:

All amounts held, controlled, or in process of distribution by a retirement plan, for the payment of benefits as an annuity, pension, retirement allowance, disability payment, or death benefit from a retirement plan are exempt.

Section 704.115(b) is directed toward non-bankruptcy creditor exposure – a “retirement plan” is exempt from a judgment creditor – depending on the type of the plan.

But what is a “retirement plan” within the meaning of Section 704.115? Section 704.115(a) provides that “retirement plan” means, for purposes of Section 704.115(b):

(1) Private retirement plans, including, but not limited to, union retirement plans.

(2) Profit-sharing plans designed and used for retirement purposes.

(3) Self-employed retirement plans and individual retirement annuities or accounts provided for in the Internal Revenue Code of 1986, as amended, including individual retirement accounts qualified under Section 408 or 408A of that code, to the extent the amounts held in the plans, annuities, or accounts do not exceed the maximum amounts exempt from federal income taxation under that code.

(4) Retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under Sections 403, 414, or 457 of the Internal Revenue Code of 1986, as amended, to the extent the amounts held in the plans, annuities, or accounts do not exceed the maximum amounts exempt from federal income taxation under that code and are not otherwise exempt under federal law.

Thus: profit-sharing plans designed and used for retirement purposes, but also “private retirement plans,” are exempt. Above, we saw that, under Section 704.115(b), if monies are held, controlled, or distributed from a “retirement plan” – including any remaining death benefit under the “retirement plan” – those monies “are exempt.” . . . Period. Section 704.115(d) provides that, “After payment, the amounts described in subdivision (b) and all contributions and interest thereon returned to any member of a retirement plan are exempt.” When it comes to California private retirement plans and profit-sharing plans, from a non-bankruptcy court judgment creditor exposure standpoint, that is the end of the matter – those plans – and lifetime and death distributions therefrom – are exempt (protected). (We are assuming that the California private retirement plan or profit-sharing plan was bona fide and created for actual retirement purposes and was maintained and administered for retirement purposes.)

But a close reading of Section 704.115(b) illustrates that the California legislature carves out with Section 704.115(a)(3)-(4) different treatment for “self-employed retirement plans” and “individual retirement annuities” (IRAs), as well as monies in Section 403, 414, or 457 retirement plans. Section 403, 414, and 457 plans are often known as government, church, and not-for-profit plans (and certain defined contribution plans). In contrast to Section 704.115(a)(1)-(2)-listed retirement plans – profit-sharing plans designed and used for retirement purposes and private retirement plans – retirement plans contemplated under Section 704.115(a)(3)-(4) – self-employed retirement plans, IRAs, and Section 403, 414, or 457 retirement plans – are exempt from exposure to judgment creditors to the extent those funds “held in the plans” “do not exceed the maximum amounts exempt from federal income taxation” under the Internal Revenue Code and, as I explain next, self-employed retirement plans, IRAs, and Section 403, 414, or 457 retirement plans not otherwise exempt under federal law are still subject to a “means test” at the discretion of the judge presiding over the California judgment enforcement action; Section 403, 414, or 457 retirement plans, however, are protected in full if “otherwise exempt under federal law” (namely, ERISA), otherwise, Section 403, 414, or 457 plans are likewise subject to the “reasonably necessary” for retirement means test of Section 704.115(e). To be clear, Section 704.115(a)(3)-(4)-type plans and accounts are subject to this means test even if funds have not been distributed – the judgment creditor may attempt to persuade the judge that part or all of the IRA balance is not “reasonably necessary” for the IRA owner’s retirement and bust the IRA wide open (unless it is a Section 704.115(a)(4) plan that is otherwise governed by federal law). A 401(k), in contrast to an IRA, is ERISA-governed – and protected. A particular “problem” with IRAs and other qualified retirement accounts subject to Sections 401 or 408 of the Internal Revenue Code is that the Internal Revenue Service (IRS) requires that, at some point (a topic for another day), funds in these qualified retirement accounts begin to be distributed from the plan – a real payday for a judgment creditor unless the plan distributions are protected under California Code of Civil Procedure Section 704.115(a)(1)-(2) or ERISA. But the worry begins long before the Section 704.115(a)(3)-(4) account owner’s retirement and also before the time when any potential required minimum distributions begin – a judgment creditor can come in under Section 704.115(e) and attempt to show that the IRA or similar non-Section 704.115(a)(1)-(2) account or plan (not a California private retirement plan and not a profit-sharing plan, nor a Section 704.115(a)(4) plan that is otherwise protected under federal law) fails the so-called retirement means test.

While profit-sharing plans designed and used for retirement purposes and private retirement plans are exempt from judgment creditors in full, self-employed retirement plans, IRAs, and Section 403, 414, or 457 retirement plans are exempt from judgment creditors to an extent – not only plan distributions but also plan holdings will be exposed, subject to what some practitioners refer to as the above mentioned “means test” (as would monies in such plans to the extent the value of such a plan exceeds “the maximum amounts exempt from federal income taxation” under the Internal Revenue Code, except that Section 403, 414, or 457 retirement plans that are  “otherwise exempt under federal law” should be protected). Contrast an ERISA-governed 401(k) (often protected) with a non-ERISA-governed IRA (subject to Section 704.115(e) means test, which was already the case prior to AB 2837). Section 704.115(e)(1) indeed provides:

Notwithstanding subdivisions (b) and (d), except as provided in subdivision (f), the amounts described in paragraphs (3) and (4) of subdivision (a) are exempt only to the extent necessary to provide for the support of the judgment debtor when the judgment debtor retires and for the support of the spouse and dependents of the judgment debtor, taking into account all resources that are likely to be available for the support of the judgment debtor when the judgment debtor retires.

Thus, the result of AB 2837, as effected in the new Section 704.115, is to expose to judgment creditors the holdings and balances of, as well as distributions from, those retirement plans enumerated in Section 704.115(a)(3)-(4) – self-employed retirement plans, IRAs, and Section 403, 414, or 457 retirement plans (unless the Section 403, 414, or 457 plan is otherwise protected under federal law). Section 704.115(d) – applicable to profit-sharing plans designed and used for retirement purposes and private retirement plans and exempting in full from judgment creditors monies held, controlled, or distributed – and any death benefits remaining – is inapplicable to retirement plans enumerated in Section 704.115(a)(3)-(4) – plan holdings and balances of, as well as distributions from, self-employed retirement plans, IRAs, and non-ERISA-governed Section 403, 414, or 457 retirement plans (as per a plain reading of Section 704.115(e)(1)).

In sum, while funds in profit-sharing plans designed and used for retirement purposes and private retirement plans are protected in full from judgment creditors – regardless of whether the funds are held by the plan or are distributed (for retirement purposes, of course), and upon death – AB 2837 causes the holdings and balances of, and distributions from, self-employed retirement plans, IRAs, and Section 403, 414, or 457 retirement plans to be exposed to judgment creditors if (1) the plan fails the Section 704.115(e) means test, except that Section 403, 414, or 457 retirement plans that are “otherwise exempt under federal law” (ERISA-protected plans such as a 401(k) or other retirement plan subject to ERISA) in general ought to be protected.

Tracing is another major, real problem with distributions from Section 704.115(a)(3)-(4)-type plans – it can be very expensive and time-consuming to try to prove to where monies distributed from Section 704.115(a)(3)-(4)-type plans were rolled over or on what the monies were expended. That problem is avoided with a California private retirement plan (trust) that was set up, maintained, and administered in the proper manner.

It should be clear that a traditional IRA – both the balance therein and distributions therefrom – is indeed subject to the Section 704.115(e) means test as IRAs are not subject to ERISA.

It will be critical for individuals to discuss their retirement plans with their employer, plan custodian, and estate planning attorney. Whether a particular retirement plan is subject to ERISA should be confirmed by the employer or custodian in writing. If you have a government, church, not-for-profit, or defined contribution plan, it may be advisable to have your employer or plan custodian confirm in writing whether the plan is nevertheless subject to ERISA.

It should be noted that certain retirement plans that may not enjoy federal ERISA protection may nevertheless constitute profit-sharing plans designed and used for retirement purposes or private retirement plans under Section 704.115(a)(1)-(2) such that the non-ERISA-governed retirement plan can claim the triple crown – protection for funds held by, distributed from, or inherited from the non-ERISA-governed retirement plan. While it may appear, for example, that a solo 401(k) plan – solo 401(k) plans are in general not governed by ERISA – may constitute a “retirement plan” under Section 704.115(a)(1)-(2), the issue of whether a particular retirement plan indeed constitutes a “retirement plan” under Section 704.115(a)(1)-(2) such that the plan is protected in full under Section 704.115(d) and immune to the means test is very fact-specific and should be discussed with a retained California asset protection attorney.

A final point to emphasize is that the retirement plan – California private retirement plans and profit sharing plans but also non-ERISA plans seeking to constitute California private retirement plans or profit sharing plans under Section 704.115(a)(1)-(2) (again, a solo 401(k) plan, for instance) – must be designed and used for retirement purposes. A California private retirement plan – a trust that your employer or your company settles for you, as a W-2 employee, in practice – or profit-sharing plan must have as its sole, primary purpose retirement planning. To achieve the asset protection benefits built into Section 704.115(a)(1)-(2), the California private retirement plan or profit-sharing plan – and, again, any non-ERISA plan that may seek to be deemed to be a California private retirement plan or profit-sharing plan – cannot be the employee’s personal piggy bank or alter ego.

But one interesting and unintended effect of a proper California private retirement plan that may result is that the existence of the California private retirement plan (or 401(k)) is that such a plan is the very type of resource that Section 704.115(e) directs the judge to “take into account” as “likely to be available for the support of the judgment debtor when the judgment debtor retires.” Synthesizing retirement account distributions and understanding how they relate from not only a financial and tax perspective but also an asset protection and creditor exposure perspective is crucial.

A lot of due diligence and legal work goes into creating, maintaining, and administering over time a California private retirement plan. As Section 704.115 illustrates, and as I hope this article does, a California private retirement plan affords California higher income earners excellent asset protection benefits – unaffected by AB 2837. If you believe you have several working years left (if you believe you will continue to be employed as an employee for several more years) and earn several hundred thousand dollars of income per year (often through your own company), a California private retirement plan could be an important part of your comprehensive estate plan – even if you already have a 401(k), government plan, church plan, not-for-profit plan such as a 403(b) plan at a hospital, or other retirement plan. Another component of your comprehensive estate plan could include South Dakota asset protection planning – an appropriate irrevocable domestic asset protection trust – and perhaps one or more of those trusts could be the beneficiary of your California private retirement plan.

In conclusion, proactive planning is more important than ever: not all retirement plans are created equal. Coordinate with a California estate planning attorney to evaluate whether your plan qualifies for treatment under Section 704.115(b) and whether a California private retirement plan may be appropriate for you. Do not make financial or plan changes or transfer assets without formal legal guidance.

This article is the author’s current opinion in an area of law that is always changing and complex; it does not constitute legal advice.  Please contact California estate planning attorney Ryan J. Casson to discuss retaining him regarding California bankruptcy or debtor counseling, creditor counseling, estate planning and asset protection counseling, or counseling about how and when it may be appropriate to integrate with your California private retirement plan a South Dakota dynasty trust.

The best time to evaluate your exposure is before any claim arises, while you have proactive options.