Is Your Retirement Plan Really Safe? Protecting Qualified ...

Richard A. Naegele

Attorney at Law

35765 Chester Road Avon, OH 44011-1262 Direct: (440) 695-8074 Email: RNaegele@

Fellow, American College of Employee Benefits Counsel

Main: Fax: W eb:

(440) 695-8000 (440) 695-8098 W

Is Your Retirement Plan Really Safe? Protecting Qualified Plans and IRAs From Creditors

by

Richard A. Naegele, J.D., M.A.

Presented at:

The Group Annual Meeting

February 19 - 22, 2012 San Diego, California

BOT-00046.1202\733703.doc

chapter 13

Is Your Retirement Plan Really Safe? Protecting Qualified Plans and IRAs From Creditors

Table of Contents

I.

INTRODUCTION .........................................................................................................................13.1

II.

THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT

OF 2005 ("BAPCPA") ...................................................................................................................13.1

A.

Key Points of BAPCPA for Retirement Plan Assets..........................................................13.1

B.

Further Analysis Under BAPCPA.....................................................................................13.3

C.

Inherited IRAs. ................................................................................................................13.4

III. ERISA AND INTERNAL REVENUE CODE ANTI-ALIENATION PROVISIONS ......................13.6

A.

ERISA. ............................................................................................................................13.6

B.

Internal Revenue Code. ....................................................................................................13.7

C.

Exceptions. ......................................................................................................................13.7

D.

ERISA Preemption.........................................................................................................13.11

E.

Supreme Court Acknowledgment Outside of Bankruptcy................................................13.11

F.

General Creditors of the Sponsoring Employer. ..............................................................13.11

IV. ADDITIONAL ANALYSIS ........................................................................................................13.12

A.

Patterson v. Shumate......................................................................................................13.12

B.

Yates v. Hendon. ............................................................................................................13.12

C.

Owner-Only Plans Are At Risk Outside of Bankruptcy. ..................................................13.13

D.

403(b) Plans May Not Be Protected Outside of Bankruptcy. ...........................................13.14

E.

ERISA Protections Do Not Apply to Funds After Distribution From Retirement

Plan (But Bankruptcy Protections May Apply). ..............................................................13.14

F.

Impact of Bankruptcy on a Qualified Domestic Relations Order......................................13.14

V.

INDIVIDUAL RETIREMENT ACCOUNTS...............................................................................13.15

A.

IRAs in Bankruptcy ? 2005 Bankruptcy Act (BAPCPA). ................................................13.15

B.

IRAs in State Law (Non-Bankruptcy) Creditor Actions...................................................13.15

C.

Ohio Law.......................................................................................................................13.17

D.

Treatment of IRAs with Prohibited Transactions.............................................................13.18

CHART: State-By-State Analysis Of Individual Retirement Accounts As Exempt Property........................13.21

13 ? Pension and Profit-Sharing Plan Overview and Update

BOT Oscpa Seminar\77200.doc

chapter 13

Is Your Retirement Plan Really Safe? Protecting Qualified Plans and IRAs From Creditors

I. INTRODUCTION

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") brought much needed clarity to debtor and creditor rights relative to retirement assets in a federal bankruptcy proceeding. Prior to BAPCPA, debtor and creditor rights with regard to such assets were in a state of great confusion both within and outside of federal bankruptcy. For debtors in financial distress under the federal bankruptcy laws, BAPCPA not only provides clarification but actually extends bankruptcy protection for the debtor's retirement funds. For debtors in financial distress who are subject to state attachment and garnishment proceedings outside of bankruptcy, the confusion continues.

II. THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005 ("BAPCPA")

A. Key Points of BAPCPA for Retirement Plan Assets.

1. BAPCPA makes significant changes in bankruptcy rules and adds specific protections for tax-qualified retirement plans and IRAs. BAPCPA is effective for bankruptcy petitions filed on or after October 17, 2005.

2. BAPCPA exempts retirement plan assets from a debtor's bankruptcy estate if such assets are held by an Internal Revenue Code Section 401(a) tax-qualified retirement plan, a section 403(b) plan, a section 457 plan, or an IRA (including traditional IRAs, Roth IRAs, SEPs and SIMPLEs) under Sections 408 or 408A. The retirement plan exemption applies regardless of whether the debtor elects the federal or state bankruptcy exemptions. 11 USC ? 522(d)(12).

? 2011 by Richard A. Naegele and Mark P. Altieri

Protecting Retirement Plan and ? 13.1

IRA Assets from Creditor Claims

Earlier versions of this chapter were published in The Practical Tax

Lawyer (Winter, 2008) by ALI-ABA, The ASPPA Journal (Fall, 2007),

The Journal of Deferred Compensation (Winter, 2007) by Aspen

Publishers, The Journal of Accountancy (January, 2006 and April,

2005) by the American Institute of Certified Public Accountants, The

Tennessee CPA Journal (January, 2003) by the Tennessee Society of

CPAs, republished, Journal of Pension Planning and Compliance

(Spring, 2003) by Aspen Publishers, and The CPA Journal (October,

2000) by the New York State Society of CPAs, republished Journal of

Pension Planning and Compliance (Winter, 2001) by Panel Publishers

BOT Oscpa Seminar\77200.doc

3. The exemption for IRAs is limited to $1,171,650. However, the $1,171,650 limit does not apply to employer-sponsored IRAs (e.g., SEPs or SIMPLEs). Additionally, rollovers into IRAs from qualified plans are also exempt from the $1,171,650 limit. It appears that a rollover from a SEP or SIMPLE-IRA would receive only $1,171,650 of protection since a Code Section 408(d)(3) rollover is not one of the rollovers sanctioned under Bankruptcy Code Section 522(n).

In order to make sure that an individual receives the full $1,171,650 exemption on contributory IRAs and the unlimited exemption on IRA rollovers, it is a good idea to establish separate IRA rollover and contributory IRA accounts. This will make it easier to track the separate pools of assets.

4. BAPCPA exempts assets in retirement plans that satisfy the applicable requirements of the Internal Revenue Code. A retirement plan is deemed to be qualified under BAPCPA if it has received a favorable determination letter from the IRS. If the plan has not received a favorable determination letter, the debtor must demonstrate that: (a) neither the IRS nor a court has made a determination that the plan is not qualified, and (b) (i) the plan is in substantial compliance with the Internal Revenue Code, or (ii) the plan is not in substantial compliance but the debtor is not materially responsible for the failure. 11 USC ? 522(b). BAPCPA thereby increases the importance of obtaining an individual IRS determination letter for a qualified plan.

5. BAPCPA exempts payroll deductions to repay plan loans from the automatic stay provisions. Therefore, payroll deduction repayments may continue during the pendency of the bankruptcy proceeding. Additionally, retirement plan loan obligations are not discharged in bankruptcy.

a. But see: In re: Butler, 379 B.R. 732 (Bankr. N.D. Ohio 2007) where the court found that repayment of a 401(k) loan constituted a circumstance of the Debtor's financial situation to be considered in determining abuse. As a result, the court dismissed the Debtor's voluntary petition for relief under Chapter 7 of the Bankruptcy Code.

6. In summary, under BAPCPA, qualified plan, SEP, and SIMPLE assets are protected with no dollar limitation. IRAs and Roth IRAs are protected to $1,171,650. However, rollover assets in an IRA are not subject to the $1,171,650 limit. BAPCPA only applies to assets in bankruptcy. One must look to state law for protection of IRA assets in state law (e.g., garnishment) actions.

13.2 ? Pension and Profit-Sharing Plan Overview and Update

BOT Oscpa Seminar\77200.doc

B. Further Analysis Under BAPCPA.

1. Determination of the Tax Qualified Status of Plan.

As noted above, the bankruptcy exempted funds or accounts must be exempt from taxation under the Internal Revenue Code (IRC or Code). Section 522(b)(4) of the Bankruptcy Code provides a very lenient rule in determining whether funds or accounts are exempt from taxation under the Code. For bankruptcy law purposes, there is a presumption of exemption from tax if the fund or account has received a favorable ruling from the IRS (e.g., an IRS favorable determination letter issued to an employer-sponsored tax-qualified retirement plan). Additionally, a fund or account is considered exempt from tax even if it has not received a favorable IRS ruling provided that it is in substantial compliance with the Code. Lastly, even if the fund or account has neither a favorable ruling nor is in substantial compliance with the Code, it is still considered exempt for bankruptcy law purposes if the debtor is not materially responsible for its noncompliance.

It is not clear to what extent a prototype or volume submitter letter from the IRS will be considered to be a favorable ruling from the IRS for bankruptcy purposes. Therefore, it is a good idea for such plans to file for individual determination letters from the IRS in order to assure maximum creditor protection.

2. Power of Court to Examine Plan's Qualified Status.

Another issue of concern is the extent to which a court can examine a plan to determine if its tax qualified status should be revoked. The United States Fifth Circuit Court of Appeals held in In the Matter of Don Royal Plunk, 481 F.3d 302 (5th Cir. 2007) that a bankruptcy court can determine whether a retirement plan has lost its tax-qualified status, and therefore its protection in bankruptcy, because the debtor misused the plan assets. In Plunk the Fifth Circuit limited its prior ruling in Matter of Youngblood, 29 F.3d 225 (5th Cir. 1994) (holding that it is the IRS and not the courts who determine a plan's taxqualified status) to cases where the IRS has reviewed the alleged disqualifying defect and ruled that the plan is still qualified.

3. Retirement Plan Distributions.

BAPCPA provides limited post-bankruptcy protection for distributions of retirement plan assets to plan participants. "Eligible rollover distributions" retain their exempt status after they are distributed. 11 USC ?522(b)(4)(D). It is unclear whether such distributions are protected for more than 60 days if they are not rolled over to an IRA or to another qualified plan. Minimum required distributions and hardship

BOT Oscpa Seminar\77200.doc

Protecting Retirement Plan and ? 13.3 IRA Assets from Creditor Claims

distributions are not protected since they are not eligible rollover distributions.

4. Owner Only Plans are Protected in Bankruptcy.

As will be detailed below, there is case law and Department of Labor ("DOL") Regulations holding that a qualified retirement plan that benefited only the business owner (and/or the owner's spouse) was not an Employee Retirement Income Security Act ("ERISA") Plan and, therefore, could not invoke ERISA anti-alienation protections either inside or outside of bankruptcy. Within a federal bankruptcy proceeding, this concern has been eliminated to the extent that the debtor has a favorable ruling from the IRS or is otherwise deemed to have a tax-exempt plan as noted above.

5. Exception to "Anti-Stacking" Rule.

BAPCPA added Bankruptcy Code Section 522(b)(3)(C) which creates an exception to the "anti-stacking" clause of Bankruptcy Code Section 522(b)(1). The anti-stacking clause generally requires that a debtor choose between federal and state law exemptions. Under Section 522(b)(3)(C), even if the debtor chooses the state law exemptions, he can still exempt from his bankruptcy estate any of his "retirement funds" under federal law exemptions. In enacting BAPCPA, Congress created a new class of exemptions for certain retirement funds regardless of whether the state of domicile of the debtor has opted out of the federal scheme for other property. For retirement funds, 11 U.S.C. ? 522(b)(3)(C) is applicable to opt-out states and 11 U.S.C. ? 522(d)(12) applies in the federal exemption scheme. The two provisions are identical and provide for an exemption for: retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under Sections 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code. In re: Thiem, 107 AFTR 2d 2011-529, (Bankr. D. Ariz. 2011). In re: Patrick, 411 B.R. 659 (Bankr. C.D. Cal. 2008).

C. Inherited IRAs.

1. Split in Authority.

Courts have disagreed on whether an IRA inherited by someone other than a surviving spouse may be exempted from the debtor's bankruptcy estate. As noted in II.B.5 above, under Bankruptcy Code ?? 522(b)(3)(C) and 522(d)(12), the exemption of a retirement plan asset, including an IRA, is based on the Bankruptcy Code. This is true even for states such as Ohio which have chosen to opt out of the Federal exemptions and create their own statutory exemptions.

13.4 ? Pension and Profit-Sharing Plan Overview and Update

BOT Oscpa Seminar\77200.doc

2. Exempt in Bankruptcy: Cases.

In In re: Nessa, 426 B.R. 312 (B.A.P. 8th Cir. 2010), an Eighth Circuit Bankruptcy Appellate Panel held that a Section 522(d)(12) exemption must meet two requirements: (1) the amount the debtor seeks to exempt must be retirement funds, and (2) those retirement funds must be in an account that is exempt from taxation under Sections 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code. The Nessa court affirmed the decision of the bankruptcy court that assets in a debtor's inherited IRA were "retirement funds" and that the IRA was exempt under IRC ? 408(e). Thus, the exemption under ? 522(d)(12) was applicable. The court further noted that Bankruptcy Code ? 522(b)(4)(C) provides for the direct transfer of retirement funds from an IRA and that such transfer will not cause the funds to fail to qualify for the bankruptcy exemption. See also: In re: McClelland, 2008 WL 89901 (Bankr. D. Idaho 2008); In re: Weilhammer, 2010 WL 3431465 (Bankr. S.D. Cal. 2010); In re: Kuchta, 434 B.R. 837 (Bankr. N.D. Ohio 2010); In re: Thiem, 107 AFTR 2d 2011-529 (Bankr. D. Ariz. 2011); In re: Mathusa, Case No. 6:10bk-13336-KSJ (Bankr. M.D. Fla. 2011) (citing 11 U.S.C. ?522(b)(3)(C) and Nessa); Chilton v. Moser, 444 B.R. 548 (E.D. Tex. 2011); In re: Kalso, 2011 WL 3678326 (Bankr. E.D. Mich. 2011), where the court concluded that the debtor's inherited IRA was exempt under ?522(d)(12) ("The language of ?522(d)(12) does not make a distinction as to who contributed the funds to the IRA").

3. Not Exempt in Bankruptcy: Cases.

A contrary view was adopted by a bankruptcy court in Texas in In re: Chilton, 426 B.R. 612 (E.D. Texas 2010). In Chilton, the court determined that funds in an inherited IRA were not "retirement funds" and that an inherited IRA was not tax exempt under IRC ?408. As a result, the court held that the inherited IRA was not exempt from the debtor's bankruptcy estate. However, Chilton was reversed by the court in Chilton v. Moser, 444 B.R. 548 (E.D. Tex. 2011).

The line of cases that deny exemptions in inherited IRAs commonly conclude that inherited IRAs are (1) fundamentally different from a traditional IRA under the IRC and (2) lack a retirement purpose. These courts determined that an inherited IRA is (1) subject to an entirely different set of rules upon the use, distribution and taxation of the funds, and (2) no longer used for retirement purposes but is "a liquid asset which may be accessed by [the debtor] at his discretion without penalty, and which he must take as income within a relatively short period of time without regard for his retirement needs." In re: Sims, 241 B.R. 467, 470 (Bankr. N.D. Okla. 1999) (Oklahoma law); see also In re: Ard, 435 B.R. 719 (Bankr. M.D. Fla. 2010) (Florida law and citing case law for 11 U.S.C. ?522(d)(12), and citing Robertson v.

Protecting Retirement Plan and ? 13.5 IRA Assets from Creditor Claims

BOT Oscpa Seminar\77200.doc

Deeb, 16 So. 3d 936 (Ct. App. 2 Dist. 2009) (non-spousal inherited IRA not exempt from garnishment); In re: Klipsch, 435 B.R. 586 (Bankr. S.D. Ind. 2010) (Indiana law); In re: Jarboe, 365 B.R. 717 (Bankr. S.D. Tex. 2007) (Texas law); In re: Taylor, 2006 WL 1275400, at 2 (Bankr. C.D. Ill. 2006) (Illinois law); In re: Navarre, 332 B.R. 24 (Bankr. M.D. Ala. 2004) (Alabama law); In re: Clark, 2011 WL 1814209 (Bankr. E.D. Wisc. 2011) (Wisconsin law and BAPCPA).

4. Ohio Cases.

An excellent analysis of the law is provided in In re: Kuchta, 434 B.R. 837 (Bankr. N.D. Ohio 2010). In Kuchta, the court determined that an IRA inherited by a non-spouse would not have been exempt under Ohio Revised Code (ORC) ? 2329.66(A)(10)(c) since the debtor had not established the IRA and had not contributed wages or other earnings to it. The court further held, however, that the inherited IRA was exempt from the debtor's bankruptcy estate under 11 U.S.C. ? 522(b)(3)(C). The court discussed both Nessa and Chilton but agreed with Nessa that an inherited IRA constituted retirement funds and that the IRA was exempt from tax.

Thus, following Kuchta, an inherited IRA should be exempt from a debtor's bankruptcy estate in Ohio. Outside of bankruptcy, however, protection from creditor claims in Ohio would be based on ORC ?2329.66(A)(10)(c). Under the analysis of the court in Kuchta, inherited IRAs in Ohio would not be protected from creditors outside of bankruptcy. See also In re: Reinhard, Case No. 08-15357 (Bankr. Ct. N.D. Ohio 2010).

5. Tax Qualified Retirement Plans.

The issue of creditor protection for an inherited account under a taxqualified retirement plan should not arise since a debtor's assets in a qualified plan are protected both under the Bankruptcy Code and ERISA.

III. ERISA AND INTERNAL REVENUE CODE ANTI-ALIENATION PROVISIONS

A. ERISA.

Title I of ERISA requires that a pension plan shall provide that benefits under the plan may not be assigned or alienated; i.e., the plan must provide a contractual "anti-alienation" clause.1

1 See ERISA ? 206(d), 29 U.S.C. ? 1056(d)(1).

13.6 ? Pension and Profit-Sharing Plan Overview and Update

BOT Oscpa Seminar\77200.doc

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download