I just recently started fooling with encryption today on my bionic. When it's coming to ICS, the phone has to be in media device mode to encrypt the files. I ran tests on both the internal storage and external storage as follows.
I placed two folders on each drive (Internal and sd card) Called mass and device.
Then I started the usb connection as mass storage, moved an mp3 song to the mass folders. Next I put the usb mode in media device and placed an mp3 in each of the folders named device.
I found that when transferring files in mass storage mode, whether loading them onto the internal storage or the sd card the files never got encrypted. Only in media device mode did the files get encrypted. I proved this by pulling out the sd card and running it with my card reader. The files in mass folder played fine. The files in the device folder were visible, but would not play.
This works the other way around as well. When making backups, be sure you're in mass storage mode, otherwise the files will be encrypted. Why? Because if the phone messes up and you have to do a factory reset, you will lose access to all of your encrypted files both on the sd card and internal storage. I know, I deliberately did a hard reset to see what would happen.
If you're running Linux and not windows while transferring files, those files will not be encrypted.
In conclusion, running windows xp with moto helper installed. File going to the phone and coming from the phone will NOT be encrypted in "Mass storage" mode. Files going to the phone or coming from the phone in "Media Device" mode WILL be encrypted.
There is no known way to decrypt files on your computer encrypted by the phone itself, this is why it's best to back up files unencrypted to the computer and re encrypt them (If you so choose) with truecrypt or a similar program of choice.
I'm new to encrypting, be sure to test out my findings.