On November 4, the Bankruptcy Appellate Court for the Eight Circuit upheld a Minnesota Bankruptcy Court's earlier decision that an individual retirement annuity, funded with a single premium, had not lost its tax-qualified status and therefore, was an exempt asset in a debtor's bankruptcy.
Some background on retirement account protection in bankruptcy proceedings
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act was passed into law. In general, the law made it easier for creditors to recoup the funds they are owed during bankruptcy, but there was a silver lining of sorts for IRAs and other retirement accounts.
Under federal law, company plans, including SEP IRAs and SIMPLE IRAs, are completely protected from creditors in bankruptcy, no matter how large the account is. For instance, a client with $5 million in a 401(k) with no other money or assets to pay his creditors could likely file for bankruptcy and keep his entire 401(k). Furthermore, any rollovers of funds from company plans to IRAs retain their unlimited bankruptcy protection.
Contributions made directly to IRAs/Roth IRAs also have strong protection. Under the same law, these accounts were granted $1 million of inflation-adjusted protection for contributions made directly to those accounts and their earnings. That inflation-adjusted limit is currently $1,245,475.
Given the strong protection retirement accounts have in bankruptcy, bankruptcy trustees have recently adopted the tactic of trying to disqualify a retirement account by any means necessary. The reason being, of course, is that if the trustee can uncover a prohibited transaction or, in some other way, disqualify a retirement account, the funds are no longer considered to be in a retirement account and will then be available to creditors. Such was the case in Running v. Miller.
Facts of the case
On April 13, 2009, Joseph Miller purchased an individual retirement annuity – a type of individual retirement arrangement from Minnesota Life Insurance Company, which is owned by Securian. The full purchase price of the annuity, $267,319.48, was funded via a rollover from another of Miller's retirement accounts. Under the terms of the annuity, which was designed to be an immediate annuity, Miller was to receive eight annual payments of $40,497.95, beginning April 12, 2010. Furthermore, in the event Miller needed to access a lump-sum earlier, the contract offered a liquidity feature allowing him to take a single withdrawal of up to 75 percent of the present value of his remaining payments.
A few years later, on June 6, 2012, Miller filed for Chapter 7 bankruptcy protection. As part of the filing, Miller listed his property including, what he called, his "IRA-Securian," which, at the time, had a value of $236,370.23. Although Miller included the IRA annuity in his overall assets, he also claimed it was exempt from his bankruptcy estate under federal bankruptcy law.
During the bankruptcy proceedings the bankruptcy trustee assigned to the case, Terri Running, countered Miller's claim and asserted that the annuity should not be protected. The United States Bankruptcy Court for the District of Minnesota, which first heard the case, sided with Miller and ruled the annuity was an IRA annuity and thus, an exempt asset. Running was unwilling to let the matter go easily, and appealed the decision to the U.S. Bankruptcy Appellate Panel for the Eight Circuit.
In her appeal to the Appellate Panel, Running pinned her case on the argument that the Securian annuity did not meet the requirements of an individual retirement annuity under the tax code.
From Section 408(b) of the Tax Code:
