MICHIGAN BANKRUPTCY: PROTECTING AN IRA IN CHAPTER 7 AND CHAPTER 13
In Chapter 7 and Chapter 13 bankruptcy, the primary dynamic for the individual filing bankruptcy is the exemption, or protection, of personal assets. If you have too much stuff, or the wrong kind of stuff, it will be exposed one way or another in the bankruptcy process.
In order to “protect” your assets, your Michigan bankruptcy attorney will, on paper, apply what is called an “exemption” to each and every item of property that you own.
What are exemptions?
They are legal exceptions, allowing you to remove certain types of property up to certain dollar-value caps (depending on the type of property in question) from the “Bankruptcy Estate” that is created automatically by law with the filing of the Chapter 7 or Chapter 13 petition.
When you file bankruptcy, a Chapter 7 Trustee or Chapter 13 Trustee is automatically assigned by the Federal Bankruptcy Court to act as Trustee of this Bankruptcy Estate.
In a Chapter 7 bankruptcy, the job of the Chapter 7 Trustee is to seize and liquidate all assets that have not been fully exempted in order to generate a pool of money to distribute to your creditors, who otherwise will have their debts fully discharged (unless a debt is not dischargeable, of course).
In a Chapter 13 bankruptcy, no assets are liquidated, but the monthly Chapter 13 Plan Payment that you send to the Chapter 13 Trustee will need to be large enough to pay the dollar value of your non-exempted property to your unsecured creditors, after all higher priority creditors are fully paid. In other words, in Chapter 13, you don’t lose any property—but non-exempt property will make your Chapter 13 process much more expensive.
The exemptions are statutory, meaning that they originate in a statute, or law. The U.S. Bankruptcy Code contains the so-called Federal exemptions. A Michigan state statute contains the alternative Michigan exemptions.
In Michigan, you are allowed to choose to use either the Federal exemptions or the Michigan state exemptions. However, you cannot pick and choose individual property exemptions from one source and then another.
In most cases, the Federal exemptions are more robust. There are types of property that are better protected with the Michigan exemptions, however.
One will be discussed below.
When it comes to IRA accounts, not all “IRAs” are equal under the law in terms of exemption and protection.
PROTECTING YOUR IRA IN BANKRUPTCY: TRADITIONAL AND ROTH IRAs
The first point of note is that there are different types of IRAs. Depending on what type of “IRA” you have, it may or may not be something that can be exempted in Chapter 7 or Chapter 13 bankruptcy.
Generally speaking, a tax-qualified retirement account (as defined by various provisions of the IRS Code) can be exempted from the Bankruptcy Estate and the jurisdiction of the Chapter 7 or Chapter 13 Trustee without any dollar-value cap at all using the applicable Federal exemption.
Thus, if you have a 401(k) with $700,000 in it, it can be entirely protected in bankruptcy. If you had $700,000 in cash sitting around, it would be nearly entirely unprotected as there is no exemption available for “cash” at all, other than a small Federal “wildcard” (use it on anything) exemption that may be non-existent depending on your home’s equity.
A 403(b) would likewise be fully protected in bankruptcy, as well as others.
Likewise, a traditional IRA and a Roth IRA are, on the same basis, also fully protectable in bankruptcy as they fall into the description of tax-qualified retirement accounts in the provisions of the IRS Code cited by the Bankruptcy Code.
It is, however, very important to disclose the existence of the account to your Michigan bankruptcy attorney, disclose all recent contributions, and to turn over all recent statements and the account valuation to your attorney prior to filing your Chapter 7 or Chapter 13 bankruptcy.
The Michigan state exemptions can also be used to protect a Traditional or Roth IRA—except for contributions made within 120 days of the bankruptcy filing date.
If your attorney doesn’t know about an IRA or know its value, or when you contributed to it, it won’t be exempted.
PROTECTING YOUR IRA IN BANKRUPTCY: INHERITED IRAs
In 2014, in a unanimous opinion delivered by Justice Sotomayor, the US Supreme Court held that an “Inherited IRA” cannot be exempted in bankruptcy with either the Federal or State exemptions.
The Court reasoned that an IRA inherited from another person after that person’s death do not qualify as “retirement funds” as defined by the Bankruptcy Code because such IRAs do not operate like ordinary IRAs.
In particular, an inherited IRA allows you to withdraw funds at any time without tax penalty, never allows you to invest additional funds, and requires that the funds be withdrawn in full balance within 5 years of the original owner’s death or take minimum distributions on an annual basis.
The Court noted that the purpose of the retirement account exemption is to provide a debtor in Chapter 7 or Chapter 13 bankruptcy a “fresh start” and to meet basic personal needs, including self-care in retirement. The Court held that allowing the exemption of an Inherited IRA would be a windfall to the debtor that upsets the Bankruptcy Code’s intent to balance the interests of debtors and creditors in the bankruptcy process.
This Supreme Court decision overturned a strong line of decision here in the Eastern District of Michigan and the Sixth Circuit Court of Appeals jurisdiction which had found that an Inherited IRA could be exempted.
Thus, it is crucial that you not simply tell your Michigan bankruptcy attorney, “I have an IRA.” If it was inherited, you must disclose the source of the IRA as well so that you can be properly advised as to whether bankruptcy is a good idea or a bad idea for you.
An attorney can, again, only work with the information he or she is provided by the client.
PROTECTING YOUR IRA IN BANKRUPTCY: INDIVIDUAL RETIREMENT ANNUITIES
Likewise, every financial instrument out there using the acronym “IRA” is not like every other.
There is something called an “Individual Retirement Annuity” that is sometimes referred to as an “IRA” as well.
Depending on what sort of annuity this is, with regard to the Federal retirement account exemption, it may be no different than a pile of cash sitting on your living-room floor. In other words, it may be only exemptible to the extent of the “wildcard” exemption noted above.
The Section of the IRS Code defining an Individual Retirement Annuity is very specific as to when such an instrument is subject to the open-ended Federal retirement account exemption and what it is not.
There are annuities sold by financial advisors (who, at the end of the day, are simply sales persons in search of a commission like any other) using this same term that may not meet the criteria for exemption described in the Bankruptcy Code.
Likewise, the Michigan State exemption explicitly refers to the Federal exemption in terms of its operation.
Additionally, contributions made within 120 days of the bankruptcy filing date are not exempted, nor is any portion of the annuity subject to an order of a court pursuant to a judgement of divorce or spousal or child support, or earnings on the annuity that exceed the annual premium of the annuity.
The devil is in the details with regard Individual Retirement Annuities, to be sure.
PROTECTING YOUR IRA IN BANKRUPTCY: THE BOTTOM LINE
The bottom line is that, if you are considering filing for bankruptcy and have retirement funds in what you think is an “IRA,” you will require an experienced Michigan bankruptcy attorney to ensure that your funds are protected.
Attorney Walter Metzen is a board-certified bankruptcy specialist with the specific experience you need to ensure that walking away from your debt does not also mean walking away from the retirement savings you are counting on.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best treatment of income tax debt within the bankruptcy process.