Asset Strategies

Learn more about protecting your personal and company assets.

Qualified Retirement Plans Shield Assets from Most Creditors

A well-funded retirement plan can be a business owner's best friend. Sure, there is the obvious benefit of having a retirement nest egg. And, many people are aware that retirement plans can save you money on taxes. But, what many people don't know is that retirement plans can also shield your wealth from creditors.

Every business owner with the necessary resources should establish a retirement plan. The funds in a retirement plan are, generally, tax-deferred for income tax purposes. This benefit alone usually justifies the establishment of a retirement plan, offsetting the administrative costs of starting it.

Equally importantly, however, for the small business owner, forming a retirement plan is an extremely effective asset protection strategy. Under federal bankruptcy law, the exemption for retirement plan assets is unlimited. The small business owner can shield millions of dollars in this way. So it should absolutely be a part of your asset exemption planning.


All retirement plan assets can be attached to collect alimony and child support, as well as federal taxes. ERISA (the federal Employee Retirement Income Security Act) specifically provides for these exemptions. However, these are the only exceptions where attachment is allowed.

Retirement funds are legally protected in an asset exemption plan in different ways, depending upon whether the plan is a "qualified plan" that is subject to ERISA (the federal Employee Retirement Income Security Act).

When a retirement plan is subject to ERISA, federal law provides that all of its assets will be excluded from both a bankruptcy proceeding and a state court proceeding. (In plain English, that means that creditors can't take your retirement nest egg.) This unlimited protection makes qualified plans one of the surest ways to protect wealth. However, even non-ERISA plans have significant protections.

Balance Asset Unavailability Against Protection from Risk

Some small business owners worry about the relative unavailability of retirement benefits before they reach a certain age because early withdrawals are usually subject to a penalty, as well as liability for income tax on the amount withdrawn. (For most plans, this is a 10 percent penalty. In a SIMPLE plan, the penalty would be 25 percent during the first two years of a plan, and 10 percent thereafter).

However, it may help to think of the impact on your financial situation if a creditor were to seize that amount of money. For example, if you personally own $800,000 of securities and suffer an adverse court judgment, or file for bankruptcy, you could lose the entire $800,000. In contrast, if the same $800,000 of securities is owned through a retirement plan, the entire $800,000 is protected. If you later need these resources, and withdraw the entire amount before the required age, at the very least you still save $720,000 ($800,000 less the 10 percent penalty). This amounts to a very good bargain.

Every small business owner should be aware of some basic retirement plan concepts. Today, self-employed individuals operating limited liability companies (LLCs), sole proprietorships, general partnerships, and S corporations can form retirement plans on virtually the same terms as large C corporations.

If an individual controls, directly or indirectly, more than one business entity, all of the entities will be combined in assessing whether at least one other person participates in any one of the entity's retirement plans.


In one case, a physician was successfully sued for malpractice. The plaintiff obtained a judgment of over $60,000, and sought to attach the physician's retirement plan. The physician and his spouse were participants in the plan. However, the physician also employed one other person.

While this other employee was actually employed by a corporation separate from the entity that offered the retirement plan, the two entities were both owned by the physician and his spouse, and thus were combined under the Internal Revenue Code's rules governing controlled entities. This was sufficient to bring the plan within the protections offered by ERISA.

At least one court has held that once a plan becomes ERISA-qualified because it has one other participant besides the business owner and his or her spouse, it remains qualified, even after that other participant terminated employment and participation in the plan. (However, consult a lawyer for the rules that apply in your jurisdiction.)

Retirement Plan Options for Small Business Owners

A popular retirement plan among small business owners is the SIMPLE (Savings Incentive Match Plan for Employees). The SIMPLE plan is exempt from the usual pension anti-discrimination and top-heavy rules that govern pensions. This makes administration of the plan much simpler (hence the name.)

Each year you may contribute net earnings (up to $12,000 in 2013) to your own account in a SIMPLE plan, but you must permit your employees to make similar salary-reduction contributions as well. All these contributions must be matched by the business, up to 3 percent of an employee's pay.

The SIMPLE can be formed as an amendment to an existing 401(k) plan or as an IRA (Individual Retirement Account.) The IRA version is easier to set up. However, as discussed below, the 401(k) version may be a better choice, because it may offer better protection from the claims of creditors because of its ERISA-qualified status.


If you use a SIMPLE plan, it must be the only retirement plan the business offers.

Small business owners may establish "regular" pension plans, including defined-benefit, defined-contribution, and conventional 401(k) salary-reduction plans.

An advantage of the conventional plan is the high contribution limit ($51,000 in 2013) for your own account for defined-contribution plans. The amount is even higher if you opt for a defined-benefit pension plan. Plus, you can contribute less for lower-paid or younger employees. You may also combine types of plans to get the best features of each.

As an alternative, you may choose to form a SEP (Simplified Employee Pension), under which up to the lesser of 25 percent of your salary up to $255,000 in 2013 may be contributed to an SEP-IRA. You must also contribute the same percentage of each employee's pay to individual IRAs established for each employee, but the plan is flexible: The contribution percentages can vary from year to year and you can even skip years if you wish.


While using conventional types of pension plans allows you to combine different plans to get the maximum advantage from each of them, don't forget about the complexity that can be involved for these retirement plans. The administrative costs for a conventional plan may be cost-prohibitive for the small business owner.

IRAs Offer Simplicity, But May Have Limited Asset Protection

SIMPLE and SEP retirement plans can represent an excellent strategy that small business owners can use in an asset exemption plan to shield assets from creditors. Moreover, the unlimited retirement fund exemption available for ERISA-qualified (the federal Employee Retirement Income Security Act) retirement plans applies to IRAs established through these plans. However, IRAs that are established privately are not considered ERISA-qualified.

But there is some good news. Federal bankruptcy law provides that IRA contributions and earnings up to $1,000,000 are exempt from creditor attachment and rollover IRAs converted from qualified plans have no dollar limitation. It doesn't matter whether a debtor chooses state of federal exemptions or whether the state does not allow the use of federal exemptions for other, non-retirement-fund assets.

Moreover, the federal law also exempts educations savings through education IRAs and 529 savings plans. If the savings were established more than two years prior to filing, the entire amount is exempt; if established between 365 and 730 days before filing, the exemption is limited to $5,000.

Annuities Are Exempt Assets in Many States

State laws regarding asset protection vary widely, but many states place annuities beyond the reach of creditors. (No similar federal protection is available in bankruptcy court.) An annuity is a fund that provides an equal periodic (usually monthly) amount of money to the purchaser. In most states the exemption for annuities is limited to a fixed dollar amount per month, although in some states (e.g., Florida,) the exemption can be unlimited.


Defined-benefit pension plans pay retirement benefits as an annuity. In that case, the receipts are exempt under the retirement plan exemption.

Many individuals purchase commercial annuities from insurance companies, typically as a supplement to their retirement earnings. The annuity exemption is primarily intended to cover commercial annuities. Thus, the purchase of a commercial annuity also serves as an asset protection device. It's particularly useful if you find that conventional retirement plans are too costly to set up, or you don't wish to fund a retirement plan that includes your employees.

Essentially, the cash used to purchase the annuity is converted to an exempt asset. Of course, as the cash is received back each month, it is re-converted to a nonexempt asset. The advantage is that, during the entire period it is outstanding, you have a protected source from which you can draw income.

Private Annuities Can Qualify As Exempt Assets

Although undoubtedly intended for commercial annuities, the exemption usually extends to private annuities as well. A private annuity is an arrangement, established by contract, between two individuals, who are usually family members. Private annuities are frequently used in estate planning. Usually, an older family member "sells" property, such as interests in the family business or other securities, to the younger family member in exchange for a private life annuity.

The private annuity is also a common strategy used to transfer interests in a business from parents to children. Nonvoting interests can be transferred in this way to reduce that parent's taxable estate, while allowing the parent to maintain control of the business.

Because the older family member receives a private annuity of equal value in return for the transfer, no gift tax is due on the transfer. In addition, the value transferred is removed from the taxable estate of the older family member, because the life annuity held by the older family member terminates upon his or her death. The gift and estate tax savings created by the transfer can be significant.


John Smith has operated a very successful business for many years. He now owns a stock portfolio valued at $1 million. He transfers $500,000 of the securities to his daughter in exchange for a private annuity that will pay him $1,000 per month for life. (It is assumed here that the $1,000 per month makes the exchange of equal value).

The $500,000 has been removed from Smith's taxable estate. This transfer, alone, could have saved Smith $200,000 or more in estate taxes, depending on the value of other assets he owns. In addition, no gift taxes are due, because no gift was made, as there was an even exchange.

Finally, Smith has now converted the $500,000 of securities, which formerly were within the reach of his creditors, to an exempt asset.

You should consider a private annuity if you hold substantial nonexempt assets and live in a state that exempts annuities, or if federal estate taxes are an issue for you.

While this may not be an initial strategy for the average business owner, as time passes and more wealth is generated by the business, it may become an increasingly attractive option. The annuity contract must be drafted, and the annuity valued, so that no gift tax is due on the transfer. This will normally require the services of an estate planning attorney.

Finally, it must be remembered that the assets transferred will be owned by the transferee (e.g., the child), and thus within the reach of that individual's creditors. Even here, however, the assets can be protected if the transfer is made to a trust (with a spendthrift clause) that will manage the assets for the beneficiary (See our discussion of asset protection trusts).

It's important to note that if the annuity you establish is especially valuable, you would have to claim your state's exemptions in a bankruptcy proceeding, because there is no federal exemption for annuities.

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