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 (IRAs), up to $1,245,475.00.
• IRC § 408A — Roth IRAs, up to  $1,245,475.00.
• 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

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.

In Clark v. Rameker the US Supreme Court ruled that Inherited IRA’s are not exempt as “retirement benefits” under 11 USC §522(b)(3)(C). This ruling should cover “federal” exemption claims for Inherited IRA’s under §522(d)(12) as well, which uses the identical statutory language. As a result, Inherited IRA’s are now fair game for a Chapter 7 Trustee’s liquidation efforts, subject only to a possible “wildcard” exemption (if available).

In the Clark case the debtor’s mother established a traditional IRA and named her daughter (i.e. the debtor) as the sole beneficiary of the account. When the mother died her IRA account passed to the debtor/daughter as an Inherited IRA. However, only a surviving spouse has the statutory right (per IRC §408(d)(3)(C)(ii)) to “roll over” an Inherited IRA into an IRA of their own, and it is this formal act of “rolling over” the account that causes it to retain its exempt status as a “retirement benefit”. Since the daughter in Clark did not have this “roll over” option the Inherited IRA lost its exempt status as a “retirement benefit”, much to the debtor’s chagrin.

As a prophylactic measure, whenever a surviving spouse inherits an IRA they should timely exercise their right to “roll over” the Inherited IRA into their own IRA, just in case they have to file bankruptcy in the future. No other type of beneficiary has this right.

Given the critical role that “retirement benefits” play in your financial future, the experienced bankruptcy lawyers at Hayward, Parker, O’Leary & Pinsky, Esqs. have the expertise and will take the necessary time to explain the very important interface between bankruptcy and your financial planning efforts.