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Minnesota Bankruptcy Court Rules IRA Annuity Protected from Creditors

In November, the Bankruptcy Appellate Court for the Eighth Circuit stood by an earlier decision by the Minnesota Bankruptcy court that an individual retirement annuity that is funded with a single premium had not lost its tax-qualified status. This means that it is an asset that is exempt when a debtor files bankruptcy.

The Bankruptcy Abuse Prevention and Consumer Protection Act was passed in 2005. This is a law that makes it easier for creditors to recoup the money that they are owned during the bankruptcy process. However, there was good news for retirement accounts.

Under federal law, company retirement plans, such as Simple IRAs and SEP IRAs, are protected from creditors in bankruptcy. No matter how large the account may be, it cannot be touched. For example, a client with $6 million in their 401(k) with no other money or assets to pay off their debt could file for Chapter 7 bankruptcy in Minnesota and the 401(k) no to be touched. Even rollovers would not be touched.

Contributions made direction to IRAs also retain the protection. Under the same law, the accounts were given $1 million in protection for contributions made directly to the accounts. The protection among is to be inflation-adjusted throughout the years.

Because of the strong protection that retirement accounts receive in bankruptcy, bankruptcy trustees have adopted a tactic of trying to disqualify retirement accounts by any means. The reason they give for doing this is that the trustee may be able to uncover a prohibited transaction or the funds may no longer be considered a retirement account, making it available to creditors.

In the case of Running v. Miller, there was a challenge as to whether the individual retirement annuity was truly a retirement account. It had been listed as an asset in the bankruptcy filing. However, it was an annuity from a life insurance company. The full purchase price of the annuity was funded from the rollover of another retirement account. This made the annuity an immediate annuity and eight annual payments would come out of it starting in 2010.

However, the gentleman had to file for Chapter 7 bankruptcy, listing the annuity and its over $200,000 in value. Although included, it was stated that it was exempt from being accessed by creditors.

During the proceedings, the bankruptcy trustee countered the claim that the annuity was protected. The U.S. Bankruptcy Court for the District of Minnesota sided with the debtor and ruled that the annuity was an IRA that was exempt. The decision was appealed by the trustee.

The trustee did concede that the retirement account did satisfy most of the requirements of an IRA, the argument was that terms of the contract violated two sections of the tax code, which required that the premiums not be fixed and that the annual premiums not exceed the annual contribution limits.

The Bankruptcy Appellate Panel referred to it as a “single, fixed premium” that did not require annual premiums. The panel agreed that the language in the code was not clear, but the panel ruled that there was no violation. This is a result that is boding well for clients and insurers when a client files bankruptcy.