Building a Fortress Around Your Retirement Plans

It is common knowledge that there is a strong degree of creditor protection for retirement plans.  Many people may recall that O.J. Simpson was largely insulated from the plaintiffs in his wrongful death suit due at least in part to the fact that much of his wealth consisted of pensions.

Generally, employer-sponsored retirement plans (i.e., defined benefit plans, 401(k)'s, 403(b)'s, SEP IRA's, and SIMPLE IRA's) are covered under the federal Employee Retirement Income Security Act ("ERISA").  ERISA contains "anti-alienation" provisions which means that creditors of the plan beneficiary are unable to attack it. 

Traditional IRA's and Roth IRA's are not covered under ERISA.  However, these plans also have a degree of creditor protection.  In California, such IRA's are generally exempt from bankruptcy up to $1 million.  With regard to other kinds of creditors, such plans are protected up to the extent that they are needed for retirement.  While it's up to the court's discretion, most experts agree that the $1 million threshold is a good rule of thumb for non-bankruptcy creditors as well.

However, with respect to retirement plans that are inherited from a third party, such inherited plans generally offer no asset protection from the creditors of the beneficiaries.  However, you can still provide your beneficiaries with creditor protection for the retirement plans that they will inherit from you with a properly drafted trust.

Assuming your trust is structured in a certain way, instead of naming your beneficiaries directly as the recipients of your retirement plan, you would name your trust in a very specific manner. 

There is a misconception that naming your trust as the beneficiary of your retirement plans will invariably force your beneficiaries to take out Required Minimum Distributions ("RMD's") sooner, preventing them from "stretching" out their inherited defined contribution plans.  This is not true if there are certain conditions, two of which are described below.

First, you want to make sure your trust has "conduit" provisions which force the trustee to distribute the RMD's each year to the beneficiary rather than keeping them in the trust.  The RMD's will not be protected from your beneficiary's creditors, but the rest of the retirement plan will be protected.

Second, the beneficiary designation must specifically list each beneficiary's sub-trust, rather than simply listing the "master trust."  For example, instead of filling out the beneficiary form as: "100% to the Mom & Dad Living Trust," you would fill it out as follows: "50% to the Daughter Trust established under the Mom & Dad Living Trust and 50% to the Son Trust established under the Mom & Dad Living Trust."    

Furthermore, there may be situations where preserving the ability to stretch out the RMD's is not as important as providing creditor protection for the RMD's, planning for beneficiaries with special needs, or protecting a beneficiary from his/her own financial mismanagement.  In such cases, you simply would not add "conduit" provisions to the trust, sacrificing the stretch out for other, more important reasons unique to the specific situation.

In light of all of these issues, everybody should strongly consider whether it would be prudent to name a trust as the benefiicary of a retirement plan rather than an individual.