IRA Not Exempt from Bankruptcy Creditors!

EXECUTIVE SUMMARY

The U.S. Bankruptcy Appellate Panel in the Eight Circuit found that a Chapter 7 debtor’s interest in IRAs, which were funded solely with lump sum rollovers from their former employer’s retirement plan, were not exempt from bankruptcy creditors.

FACTS

In 1999, Richard and Betty Jo Rousey, former employees of Northrop Grumman, each established an IRA in the form of deposit accounts at their bank. The IRAs were funded by rollovers from the Rousey’s qualified plans at Northrop Grumman. The Rouse’s did not deposit any further money into these IRAs since they first established the accounts. In April of 2001, the Rouseys filed a voluntary joint Chapter 7 bankruptcy petition. The couple elected to use the bankruptcy exemptions provided for under federal law, 11 U.S.C. Sec. 522(b)(1) and found in 11 U.S.C. Sec. 522(d). Mr. Rousey’s IRA totaled $42,915.32 and Mrs. Rousey’s IRA totaled $12,118.16.

They claimed exemptions of approximately $44,000 under Sec. 522(d)(10)(E) (i.e. “a payment under a stock bonus, pension, profit sharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor…”).

Approximately $10,600 total was claimed as exempt under Sec. 522(d)(5) (“The debtor's aggregate interest in any property, not to exceed in value $800 plus up to $7,500 of any unused amount of the exemption provided under paragraph (1) of this subsection.”).

In August 2001, the bankruptcy trustee objected to the Rousey’s IRA exemptions under Sec. 522(d)(10)(E).

The bankruptcy court entered an order sustaining the trustee's objection and the Rouseys appealed to a bankruptcy Appellate Panel of the Eighth Circuit.

COMMENT:

The Panel stated that there are essentially three main requirements that a debtor must meet to properly claim as exempt payments from an IRA under Sec. 522(d)(10)(E).

Such payments are exempt only if they are:

(1) received pursuant to a pension, annuity, or similar plan or contract;

(2) on account of illness, disability, death, age, or length of service;

(3) reasonably necessary for the debtor's support or for the support of a dependent of the debtor.

The Panel determined that the Rouseys’ IRAs were not “similar” to a pension plan because the payments from their IRAs are not “similar” to pensions. The Panel also determined that the Rouseys’ right to payments from their IRAs was not on account of illness, disability, death, age, or length of service because the Rouseys had complete discretion over the withdrawal of their IRA funds. In response to the Rousey’s argument that this analysis would leave all IRAs non-exempt, the Panel stated that not all IRAs are alike and therefore, their ruling does not state that an IRA could never fall under the federal exemption.

SUMMARY

Had these taxpayers kept their funds in their pension plans, they would have been exempt from creditors. It appears that the taxpayers chose to fall under the exemption of federal law as opposed to state law. It is not clear to me if the result would have been different under state law. (It’s likely we’ll be hearing from one of LISI’s Asset Protection Planning Commentators on Rousey.)

The moral of the story remains the same however: “Look Before you Leap”. (And get some expert advise).

HOPE THIS HELPS YOU HELP OTHERS!