Middletown New York Bankruptcy Lawyer

Retirement Savings and Pension Plans

Retirement savings and pension benefits are frequently an individual’s most valuable asset, and critical to their long term financial survival. Whether this type of asset can be liquidated by a Chapter 7 Trustee turns upon two (2) considerations:

· Is the fund property of the bankruptcy estate?

· If the fund is property of the estate, is it exempt?

In Paterson v. Shumate, 504 US 753 (1992), the US Supreme Court ruled that retirement plans containing a legally enforceable “anti-alienation clause” are not property of the bankruptcy estate, pursuant to 11 USC § 541(c)(2), and are thus beyond the reach of a Trustee. An “anti-alienation clause” is a provision in the retirement plan preventing creditors from seizing the retirement funds, and nearly all ERISA-qualified pensions and 401K Plans have such a clause, thereby excluding them from the bankruptcy estate.

Examples of retirement savings and pension plans that are exempt from a Bankruptcy Trustee’s reach include those funds created under the following sections of the Internal Revenue Code:

· IRC § 401—a qualified pension, profit sharing and stock bonus plan created under a trust established by an employer for the exclusive benefit of employees. This includes Employee Stock Ownership Plans (ESOP), as defined by 26 USC § 4975(e)(7)(A).

· IRC § 403—qualified annuity plans that are established by an employer for an employee under IRC § 404(a)(2) or § 501(c)(3).

· IRC § 408—Individual Retirement Accounts (IRA), up to $1,171,650.00.

· IRC § 408A—Roth IRAs, up to $1,171,650.00.

· IRC § 414—other retirement plans for controlled groups of employees, including partnerships or proprietorships, governments and churches.

· IRC § 457—deferred compensation plans.

· IRC § 501(a)—retirement plans established and maintained by defined tax-exempt organizations.

Most retirement and pension plans qualify as exempt pursuant to one of the above enumerated sections. Some plans not established pursuant to the above sections can also be exempt in bankruptcy if:

1. The retirement fund has received favorable tax deferred determination by the IRS under 26 USC § 7805, and that favorable determination remains in effect on the date of the bankruptcy filing; or

2. If the retirement fund has not received such favorable determination under § 7805, the retirement fund can still be exempt if the debtor can demonstrate that no prior contrary determination has ever been made by a court or the IRS, and (1) the fund is in substantial compliance (a rather imprecise standard, admittedly) with the applicable Internal Revenue Code requirements, or (2) if the fund is not in “substantial compliance”, the debtor is not materially responsible for that failure. Establishing a valid bankruptcy exemption using these grounds can be very complicated.

A direct transfer of retirement funds from one tax deferred fund to another tax deferred fund does not cause the transferred funds to lose their exempt status in bankruptcy. Similarly, a rollover distribution from a qualified fund that is exempt from income tax consequences does not lose its exempt status in bankruptcy, provided the rollover distribution is deposited in the new account within 60 days.

It must be noted, however, that stock options and Employee Stock Purchase Plans (ESPP) are not exempt, and thus are subject to seizure and liquidation by a Chapter 7 Trustee. These funds are used by an employer to retain employees by providing an incentive to invest in the company to earn supplemental income in the short term, when the option vests. The funds exempt in bankruptcy are only those funds intended to be replacement income for a retired debtor, and this is not the intent behind stock options and ESPPs.

While most retirement savings and pension plans are exempt from the claims of creditors and Bankruptcy Trustees, they are not exempt from tax liens (see 11 USC § 522(c)(1)(B)), and most particularly IRS tax liens. Fortunately, at the present time the IRS does not appear to have the necessary systems in place to track this type of asset, although a federal pension would seem to be much more at risk than a private pension.

Until recently it was considered fairly well established that IRAs inherited by anyone other a spouse were not tax exempt, not qualified as a retirement plan of the non-spouse beneficiary and not exempted from the bankruptcy estate of said beneficiary. This is certainly consistent with the provisions of IRC § 408(d)(3)(C)(i), which appears to provide that an inherited IRA loses its status as an IRA, unless inherited by the spouse. Some very recently reported cases have ruled to the contrary, however, suggesting that an inherited IRA may be exempt. This area of law now appears to be somewhat unsettled, and a debtor possessing such an asset should approach bankruptcy with caution.