Your pension, 401(k), IRA or other retirement benefits may be a large part of yourpersonal wealth, becoming increasingly important as you near retirement. These assets maybe the most important part of your individual wealth building strategy. Are such assetssafe from creditors who may seek to garnish or seize your retirement benefits?
The answer is that your assets held in retirement plans are generally safe fromcreditors, even if you are involved in a bankruptcy action. Your creditors cannot simply goto your retirement plan and demand money from your account. Retirement plans haveprovisions preventing creditors from seizing your benefits in them. However, exceptionsexist to this general rule, and creditors may reach your retirement plan benefits in somelimited circ*mstances.
First, one must understand the protection that federal pension law offers againstcreditor action. Most private employer retirement plans are governed and protected by afederal pension law known as the Employee Retirement Income Security Act of 1974 ("ERISA").
ERISA requires pension plans to have "spendthrift" provisions which prevent benefitsfrom being alienated from the participant. What this means is that you are protected fromboth your creditors and your own desire to spend the money before you retire or areotherwise able to under the terms of the plan.
Specifically, ERISA's anti-alienation provision requires that all pension plans containprovisions which provide that benefits may not be assigned to a creditor. The IRS has alsoruled that if a pension plan allows benefits to be alienated from the pension plan to paycreditors, the pension plan itself will lose its favorable tax status.
The U.S. Supreme Court has decided that ERISA-covered retirement plan benefits areprotected from creditors in bankruptcy. However, local federal courts have interpretedthis decision to mean that in order for pension benefits to be protected, three requirementsmust be satisfied. First, the pension plan must be subject to ERISA; second, the pensionplan must be tax-qualified under certain IRS rules; and third, the pension plan must containa written anti-alienation provision. While most pension plans meet these requirements, itis important to note that a pension plan covering only the owner, or the owner and spouse,is not considered to be an ERISA plan. Thus, the benefits in such a plan may fall outsideof the protection of the Supreme Court decision should the participant enter bankruptcy.
Other limited exceptions to ERISA's anti-alienation rules exist. The most common one iswhen someone is involved in a divorce action and one spouse claims part of the otherspouse's pension. A 1984 federal law allows assignments of pension benefits pursuant to aqualified domestic relations order. This is a state judgment order entered into inconnection with a divorce, alimony payments or child support proceedings under statedomestic relations law.
Federal tax liens are another important exception to ERISA's anti-alienation rules.Federal tax liens can attach ERISA pension plans. One issue here is whether the IRS canimmediately seize pension benefits, or if it has to wait until the participant may take adistribution. The IRS has generally been successful in persuading federal courts to allowit to immediately seize the pension to pay off the tax lien. However, state tax lienscannot attach ERISA pension plans.
ERISA's anti-alienation protection will not protect benefits once they have beendistributed outside of the retirement plan.
In contrast to retirement plans, IRAs are maintained by individuals and are not governedor protected by ERISA. SEPs, or Simplified Employee Pensions, are similar to IRAs exceptthey are set up by small employers. Like IRAs, SEPs are not protected by ERISA. IRAs andSEPs also contain spendthrift provisions, but most courts have not given IRAs and SEPsprotection against garnishment. The previously mentioned Supreme Court decision protectingpension benefits does not extend to IRAs or SEPs because they are not covered by ERISA.
Some states have enacted laws to protect IRAs, SEPs and non-ERISA retirement benefitsfrom creditors, but legislation introduced in Ohio to fully protect IRAs, SEPs and non-ERISAretirement benefits has not been enacted into law. Ohio law currently protects IRAs only tothe extent reasonably necessary for the support of the participant. Thus, a criticaldifference between ERISA covered retirement benefits and IRAs, SEPs, and non-ERISAretirement benefits is protection from creditors when the participant is in bankruptcyaction.
ERISA's anti-alienation protection rules do not apply to employee welfare plans, nor dothey apply to the increasingly popular non-qualified plans. Non-qualified plans are usuallydesigned for key executives. Unlike a traditional tax-qualified pension plan, the assets ofa non-qualified plan are considered to be part of the sponsoring corporation's generalassets until the assets are actually paid to the key executive. The assets of anon-qualified plan are thus subject to the demands of the creditors of the corporationsponsoring the non-qualified plan.
In conclusion, retirement plans should be an important part of your personalwealth-building strategy. Not only do they provide one of the few remaining tax deferralmechanisms, but in most cases retirement plan benefits are given safe haven from creditoraction.
This article was written for a general employee benefits audience. For a more detaileddiscussion of the issues presented here, you may want to review:
- William P. Brown,Patterson Protection of Plan Interest: Shield or Sieve?, Journal of Pension Planning& Compliance, Spring 1995; and
- Carla Michele Schiff, Protecting Non-ERISA Pension Funds from the Reach of Creditorsin Bankruptcy, Bankruptcy Developments Journal (student note), 1994-95.
Copyright 1995 Robert S. Melson
