Close Close

Retirement Planning > Retirement Investing

Bankruptcy court rules IRA annuity shielded from creditors

Your article was successfully shared with the contacts you provided.

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:

(1) The contract is not transferable by the owner.

(2) Under the contract—

  • (A) the premiums are not fixed,
  • (B) the annual premium on behalf of any individual will not exceed the dollar amount in effect under section 219(b)(1)(A), and
  • (C) any refund of premiums will be applied before the close of the calendar year following the year of the refund toward the payment of future premiums or the purchase of additional benefits.

(3) Under regulations prescribed by the Secretary, rules similar to the rules of section 401(a)(9) and the incidental death benefit requirements of section 401(a) shall apply to the distribution of the entire interest of the owner. (Emphasis added.)

While Running conceded that Miller’s annuity satisfied most of the requirements of individual retirement annuities, she argued that the terms of his contract violated sections 2(A) and 2(B) mentioned above, which require that contract premiums not be fixed and that annual premiums not exceed the annual IRA contribution limits. In contrast, Running said that when read together, those sections of the Code require an individual retirement annuity to have flexible, annual premiums. Of particular interest to Running was that Miller’s contract stated that “Purchase Payments are payable no later than the Contract Issue Date,” that it was a “Single Payment Annuity Contract,” and that it offered “Fixed Annuity Payment Benefits.”

The Appellate Panel’s decision

Running asserted that Miller’s annuity had what the Bankruptcy Appellate Panel referred to as a “single, fixed premium (referred to in the annuity documents as the ‘purchase payment’) of $267,319.48” and did not require annual premiums. Thus, she believed it failed to meet the requirements under the code. The Appellate Panel disagreed with this notion.

In the Appellate Panel’s view, the language of the code is far from plain – gee, there’s a shock – and in its interpretation, even though annuity contract expressly forbade any further premiums after purchase, the purchase price was not fixed. There was no requirement that Miller fund the contract with precisely $267,319.48. He simply chose to do so. Instead, he could have purchased the same contract with $250,000, or $100,000 or…well, you get the point. As a result, the Appellate Panel held that section 408(b)(2)(B) of the code, which requires that the premiums not be fixed, had not been violated.

Next, the Court turned its attention to that language in the Code regarding that annual premiums not exceed the IRA contribution limit for the applicable year. Running contended that the language of the Code dictates that annual contributions be required. The Court once again disagreed. In its view, sections 408(b)(2)(B) and 408(b)(2)(C) of the Tax Code, when read together, say that if and only if annual premiums are required, contributions may not exceed the applicable contributions limits set forth in the Code.

The Court further pointed out that it believed IRS interprets the Code in the same manner, since Running was not only unable to provide any prior case as precedent, but, furthermore, the Court could not even find a single case where the IRS had argued Running’s assertions. In addition, the Court noted that IRS’ own publication about IRAs, Publication 590, seems to agree with its position, as it says “There must be flexible premiums so that if your compensation changes, your payment can also change.”

The important message for clients

There are some cases where Courts or Appellate Panels seem to be 50/50, and almost forced to pick a side. Thankfully, such was not the case here. The Appellate Panel here pointed out that those “who regularly interpret the tax code” do not see the need for individual retirement annuities to require annual contributions in order to maintain their tax-deferred status. The Appelate Panel said that it could “conceive of no purpose served by requiring an annual premium in the case of a rolled-over IRA – no matter how de minimis,” and even went so far as to say that coming to “any other conclusion would lead to an absurd result”

This case bodes well for clients and insurers, very well. Single premium annuities, funded by tax-qualified funds, are an important component to many clients’ financial plans and to many advisors’ business models. In light of the Appellate Panel’s decision in this case, there appears to be no reason to question tax qualification, and thus, the bankruptcy protection of those investments. Furthermore, the Appellate Panel’s ardent and unequivocal refute of the trustee’s arguments in this case could help prevent other bankruptcy trustees from making what, at least in this author’s opinion, is a frivolous argument that stands little chance of succeeding.

See also:


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.