A recent decision by the 7th U.S. Circuit Court of Appeals serves as a reminder to plan custodians that they cannot assume that federal law will always trump state law when it comes to assignment of plan assets. In Johnson vs. Merrill Lynch, Pierce, Fenner & Smith, Inc., 719 F.3d 601 (7th Cir. 2013), the court held that Merrill Lynch, as a custodian holding ERISA plan assets, had “no choice” but to comply with a state court order freezing payment of plan benefits and it dismissed a federal suit brought by the plan’s administrator seeking to block the state court action.

ERISA’s anti-alienation provision generally prohibits qualified retirement plan participants from assigning or otherwise encumbering their benefit proceeds from the plan. Although there are exceptions to this rule, it generally prohibits state courts from garnishing or attaching a participant’s retirement benefits to satisfy state court judgments. This general prohibition, however, does not always stop state courts from issuing orders anyway that hinder a plan from complying with both the anti-alienation statute and the plan’s anti-alienation provisions.

These state court orders can cause real problems for plan sponsors, trustees and custodians who become faced with a difficult choice of either violating the state court order and risking contempt- of- court sanctions, or complying with the garnishment order and thereby violating ERISA and the plan document — at the risk of disqualifying the plan for preferential tax treatment.

The 7th Circuit Court’s ruling should provide some comfort to plans that decide not to ignore state court orders alienating ERISA-plan benefits, even if those orders are contrary to ERISA’s anti-alienation provision. Even so, the ruling does not absolve a plan of all responsibility to fight such a court order and attempt to meet ERISA’s and the plan’s anti-alienation provisions. IRS still could attempt to disqualify a plan if the administrator fails to follow the plan’s provisions, even though a federal court lacks jurisdiction in a civil suit. It is important, therefore, to contact plan counsel to help navigate through these decisions, because a plan can neither simply follow, nor simply ignore, state court orders.