By Gary J. Gunnett, Esq.
A substantial portion ot the typical physician’s asset base consists of his or her interest in one or more retirement plans. In most cases, the retirement plans have been carefully designed to result in the most favorable tax treatment possible; the physician (with the assistance of a team of professional advisors) has devoted considerable attention to the timing and amount of plan contributions and distributions, as well as the investment of plan assets.
Traditionally, a lesser degree of attention has been focused on another factor essential to the well-being of the physician retirement plan—the ability of creditors of the physician to attach plan assets. Even if a physician is faced with no immediate threat of personal liability, the potential is a looming presence in any physician’s life. Unfortunately, claims for malpractice liability in excess of a physician’s coverage limits are a reality in today’s litigious environment. Many physicians are also involved in other business ventures with potential for personal liability.
Inconsistencies between federal and state law have led to very different levels of asset protection, depending on the type of retirement plan vehicle in which the assets have been held. Recent legislation brings consistency in Pennsylvania.
Qualified Plans Versus IRAs
A retirement plan usually takes one of two forms: a qualified plan (i.e., a pension, profit sharing or 401(k) plan which is maintained by an employer for its employees and which meets certain requirements for favorable tax treatment), or an Individual Retirement Account (IRA). Under the terms of the Employee Retirement Income Security Act of 1974 (ERISA) and a 1992 decision of the Supreme Court of the United States (Patterson v. Shumate, 112 S. Ct. 2242 (1992)), assets in a qualified plan are protected from the ability of creditors to reach them. On the other hand, IRAs are not covered by ERISA; therefore, one must look to state law for the protection of IRAs.
IRAs in-Pennsylvania: The Barshak Case
Pennsylvania statutory law does in fact protect IRAs from attachment, subject to certain exceptions, including an exception for “contributions” in excess of $15,000 per year. At first glance the $15,000 exception does not appear to present a problem; to the extent that a physician has been able to make contributions in excess of $15,000 per year, the contributions have been made to a qualified plan—not to an IRA.
However, the meaning of the word “contribution” (as used in the Pennsylvania statute) has been explored in a case originating in a Pennsylvania bankruptcy court and culminating in a decision of the Federal Court of Appeals for the Third Circuit (In re Barshak, 106 F 3d 501 (3rd Cir. 1997)). The relatively simple facts and the procedural history of the case present an interesting study:
Mr. Barshak was a participant in a qualified plan maintained by his employer. Following the termination of his employment, he rolled his distribution (approximately $70,000) into an IRA. Mr. Barshak subsequently filed for bankruptcy. The trustee ot his bankruptcy estate sought to attach the IRA assets (to the extent that the rollover exceeded $15,000) on the theory that the rollover constituted a “contribution” to the IRA. The Bankruptcy Court agreed.
On appeal, the United States District Court for the Eastern District of Pennsylvania reversed the decision of the Bankruptcy Court, holding that a rollover from a qualified plan to an IRA is not a “contribution” to the IRA since the transaction does not “transform ordinary assets into retirement assets.” On further appeal, the Third Circuit reinstated the conclusion reached by the Bankruptcy Court, finding that the rollover was a “contribution” since Mr. Barshak had the right to receive the money outright, but chose to roll it into the IRA.
The Dilemma: Sale of the Physician’s Practice
The Barshak decision has been a disturbing presence in the lives of many physicians, particularly in the face of the realities of managed care. In recent years, many physician practices have been purchased by hospitals and other institutional providers. The disposition of the physician’s qualified plan following the sale of the practice has presented a difficult dilemma.
In order to continue the deferral of taxation (the primary goal of any physician qualified plan), the selling physician must either continue the qualified plan or find some other vehicle into which the plan assets can be rolled. While the former approach may be a solution for the short run, it is not a long term fix. IRS regulations define a qualified plan as a plan established and maintained by an employer. Therefore, if the plan sponsor ceases to exist as an employer (i.e., the plan sponsor is no longer paying wages as a result of the transfer of all of its employees to a purchasing entity), the IRS might,upon audit of the plan, conclude that the plan is not qualified
While this result is extremely unlikely within a year or so following the acquisition of the practice, it becomes more likely if a plan is still in existence a few years or more after the acquisition. Absent a substantial and immediate threat of liability, the protection of plan assets from creditors is not worth the risk of plan disqualification (and the resulting imposition of income taxes).
Since maintaining prior plans is not a long term solution, some practice sellers have looked to options available through their new employers. However, many hospitals and other purchasers simply have no qualified plan into which a distribution from a prior plan can be rolled. Even where a qualified rollover plan is available, investment options under that plan are usually limited. Therefore, physicians who are used to controlling their plan investments (either on their own or with the assistance of an investment advisor with whom they have a valued relationship) must give up this control.
In just about all respects other than protection from creditors, the termination of the physician’s qualified plan, coupled with a rollover to an IRA, has been the ideal. This approach brings closure to the plan and allows each physician in the practice to pursue investment alternatives without any involvement by the purchaser or the other physicians in the practice. It also eliminates the administrative costs previously borne by the practice.
The Good News
Of course, the decision of the Third Circuit Court in the Barshak case was inconsistent with the purpose of the $15,000 limitation contained in the Pennsylvania statute. The purpose of the $15,000 limitation is to prevent potential debtors in bankruptcy from having the ability to avoid claims of creditors by dumping substantial assets into a retirement plan; the purpose is not to permit creditors to reach assets which were previously in a protected retirement plan vehicle simply because they are moved from that vehicle to a second vehicle (e.g., an IRA).
In light of the inconsistency between the treatment of qualified plans and IRAs, as well as the limitations on the options available to selling physicians, several lobbyists (including this author) have been seeking a legislative response to the Barshak decision. On February 18, 1998, the Pennsylvania legislature in fact changed the statute to provide that a direct transfer from a retirement vehicle already subject to creditor protection (such as a qualified employer plan) to an IRA retains the same protection. The change took effect immediately.
As a result of the change, physicians who have already rolled from a qualified plan to an IRA, or are faced with the prospect of doing so, can take comfort in the fact that their retirement plan assets will continue to be protected.
Gary J. Gunnett, Esq., is a shareholder in the Pittsburgh law firm of Houston Harbaugh. His practice is focused on employee benefit plan matters for health care practitioners and other clients.