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The Private Retirement Plan: A Unique Asset Protection Alternative for the Business Owner

Posted by attorney John Goralka

California is not usually viewed as a debtor-friendly state, especially compared to Nevada. In fact, California has some of the worst laws for asset protection in the United States. The California Homestead exemption is a meager $50,000 for an individual, $75,000 for a couple and $150,000 for the elderly and handicapped. Life insurance is exempt only to $9,700 and most annuities have no meaningful protection in California.

However, there is a very unique and powerful alternative under California law. California Code of Civil Procedure Section 704.115 provides a complete exemption for the assets of "Private Retirement Plans" (PRP). A successful California business owner or professional (for example a physician with a medical practice) can set up a PRP where funds from the medical practice can be paid and held in trust for the physician's retirement. So long as the funds stay within the plan, the funds are protected from the physician's creditors. Even when the funds are withdrawn from the plan, the funds remain protected from creditors so long as the funds are kept separate and not commingled with other funds. This is a very unique and powerful advantage. The PRP can be set up on a totally discriminatory basis without providing benefits for any other employees. This PRP is very flexible but, has little statutory guidance regarding its creation or administration. The PRP is a complex legal structure that must be carefully crafted.

In the absence of statutory guidance, the California courts have focused on the need for a "plan". The key is to have a comprehensive plan for retirement and not simply allocate money indiscriminately into an account. There must be plan documents, a schedule or formula of payments made into the plan, a trustee or custodian to hold the funds in accordance with the plan documents and a schedule or formula of payments to be made upon retirement. Once the money is in the plan, it can be invested but not returned to the business owner.

There is no statutory limited on how much can be contributed. This provides a great deal of flexibility. However, the contribution must bear some actuarial relationship to how much and when funds will be paid at retirement.

California community property rules should not be overlooked for a married participant. The funds contributed would be community property unless the couple has a valid prenuptial agreement before marriage or a transmutation agreement after marriage provides that the funds are separate property. In the absence of such an agreement, the best practice may be to have the plan hold ½ of the funds for the benefit one spouse and ½ for the benefit of the other spouse.

The main benefit derived from the PRP is asset protection. Private retirement plans can be qualified to provide tax benefits, if so, the benefits then are required for other employees and tax penalties may apply for early withdrawals. The real flexibility comes from the non-qualified PRP which permits funds to be set aside for the business owner or professional without providing any benefits whatsoever to others.

Assume that you are 65 years old and make $400,000 per year. The plan might assume that you will retire at 75 and, at that point, you have a 12 year life expectancy. Inflation is 4% which makes the $400,000 almost $600,000. $5,650,000 would be required to fund that obligation. $3,820,000 would need to be in the plan to grow to $5,650,000 in 10 years. That means that the trustee of the private retirement trust can file a lien on the operating assets for $3,820,000 today. Contributions can be made into the plan to satisfy that obligations. The business or operating assets under the lien and the assets contributed to the plan will be better protected from lawsuits and creditors. You could even make a voluntary contribution of other assets such as the equity in your residence. The plan trustee can record a deed of trust on the residence which provides greater asset protection for the residence.

Private Retirement Plans are a very flexible way to obtain much greater asset protection under California law for valuable assets. The Private Retirement Plan or trust is a complex legal structure which warrants careful planning and a great deal of discussion. Call the Goralka Law Firm to explore whether the Private Retirement Plan is the asset protection tool to better protect your valuable assets.

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