Short answer – a 401(k) plan is not a “retirement plan” for California creditor protection purposes when it was expressly set up to protect IRA rollover assets from creditors. This was the holding in a 2019 California Court of Appeal decision that is still valid law and that is worth revisiting: O’Brien v. AMBS Diagnostics, LLC, 38 Cal. App. 5th 553, 562 (2019), rev. den. 2019 Cal. LEXIS 8003 (October 23, 2019)
Mr. O’Brien got into a legal dispute with his former business partners in AMBS Diagnostics, LLC (AMBS) and lost at trial, resulting in a judgment against him for over $600,000. AMBS sought to collect on its judgment and filed notices of levy against Mr. O’Brien’s assets, including four IRA accounts then valued at $465,350. (There was no dispute that the IRA funds had originally been set aside for retirement purposes.) The court ordered an assessment of what portion of the funds in O’Brien’s IRAs were necessary for his support in retirement and what portion could be used to satisfy the judgment.
This is because, under California Code of Civil Procedure (C.C.P.) § 704.115(a)(3), IRA funds, and funds held in self-employed retirement plans, are exempt from creditors “only to the extent necessary to provide for the support of the judgment debtor,” and their spouse and dependents, upon retirement. This is to be distinguished from protection from bankruptcy creditors, which is governed by federal law (and which exempts up to $1 million, indexed for inflation), and is further to be distinguished from protection of assets held in “[p]rivate retirement plans” that are “established or maintained by private employers or employee organizations, such as unions,” including “closely held corporations.” Assets held in this fashion are fully protected from creditors under C.C.P. § 704.115(b). The I.R.S. generally can invade such assets pursuant to a federal tax lien, but that was not at issue in the O’Brien case.
Mr. O’Brien was aware of the different degree of creditor protection under California law, accorded to IRAs versus employer-sponsored retirement plans. Accordingly, within 18 days the court order to assess the IRA assets for necessity in retirement, Mr. O’Brien set up a limited liability company and formed a 401(k) plan for the LLC. He then rolled over his IRA assets to the newly-established 401(k) plan, and then dissolved the LLC. He also somehow got on the record as admitting that he took these actions to protect his IRA assets from his creditors. AMBS sought to levy funds from the new 401(k) plan but the trial court sided with O’Brien, holding that the funds were fully exempt as held in a “retirement plan” notwithstanding the plan’s recent vintage.
The Court of Appeal reversed on the grounds, in part, that the full exemption available to a retirement plan rests on the assumption that the plan holding the funds was principally or primarily designed and used for retirement purposes, and in light of Mr. O’Brien’s admission the LLC’s plan simply did not meet that standard. “O’Brien freely admitted his subjective intent for creating the 401(k) plan and in transferring the funds . . . ‘[T]he shielding and hiding of assets from creditors is clearly not a “use for retirement purposes.”’” 38 Cal. App. 5th at 562, citing In re Daniel, 771 F.2d 1352, 1358 (9th Cir. 1985), In re Dudley, 249 F.3d 1170, 1177 (9th Cir. 2001), In re Bloom, 839 F.2d 1376, 1378 (9th Cir. 1988). The court concluded that the 401(k) funds were still subject to the more limited, “as necessary for retirement” protection available to IRA assets and sent the matter back to the trial court for assessment of the funds against that standard, as originally had been intended. Interestingly, in reaching this conclusion the court favorably cited an earlier decision, McMullen v. Haycock, 147 Cal. App. 4th 753, 755-756 (2007), in which funds in a retirement plan account were held to have kept their higher level of protection against creditors after having been rolled to an IRA. This “tracing rule” remains citable legal authority in California although it is somewhat at odds with the language of C.C.P. § 704.115(a)(3).
Would the outcome in the case have been different had O’Brien not been so bold about stating his intentions? Probably not, though he certainly did not help himself. The timing of the LLC and plan setup were damning enough in themselves, and it would appear from the opinion that the rollovers were made in violation of the 401(k) plan terms (AMBS alleged that “O’Brien’s purported rollover of funds was invalid because he did not meet the qualifications set forth in the 401(k) plan itself for such a rollover.”) 58 Cal. App. 5th at 558.
Clearly, a poor plan, poorly executed, and an object lesson that creditor protection of retirement plan assets will be based on all the relevant facts and circumstances, not just the name on the account.
The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.
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