Bankruptcy and Retirement Plans in 2005
Recently, the US Supreme Court, in Rousey v. Jacoway, ruled that assets held in IRAs may be protected from attachment by creditors by the Federal bankruptcy law. Following closely on the heels of that decision, Congress passed a major revision of the bankruptcy code, which confirms the protected status of IRAs and defines the level of debtor assets that may be sheltered by qualified retirement plans and IRAs.

New Bankruptcy Law
President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) into law on April 20, 2005. The BAPCPA, which will become effective 180 days later (October 17, 2005), will require debtors who seek protection in bankruptcy and whose net current monthly income is in excess of their home state’s median income to repay a portion of their debt under Chapter 13 rather than allowing them to erase their debt almost entirely under Chapter 7 of the bankruptcy code.

Retirement Plans Excluded from Bankruptcy Estate
Under BAPCPA assets held in qualified retirement plans (such as a 401(k), profit sharing, thrift, money purchase, ESOPs, and defined benefit plans), 403(b) plans, and 457(b) plans of state and local governments will be entirely protected since they are expressly excluded from the bankruptcy estate. Most importantly, the law settles a long-standing conflict between ERISA and the Bankruptcy Courts by requiring that plan participant must now continue payments on their qualified plan loans rather than suspending them. Further, the BAPCPA establishes guidelines for determining the qualified status of a retirement plan for bankruptcy purposes. A qualified plan with an IRS letter, such as a prototype plan or other pre-approved plan, will enjoy automatic bankruptcy exclusion, while the law provides standards to prove qualified status for other qualified plans without a determination letter.

IRA Bankruptcy Rules
The BAPCAP also excludes traditional IRAs and Roth IRAs from the bankruptcy estate, but only up to a $1 million limit, without regard to rollover amounts. Although Rousey v. Jacoway had settled the issue whether IRAs could be excluded from the bankruptcy estate on the same basis as qualified plans, it did not address the federal bankruptcy law provision regarding the dollar amount that could be excluded. Thus, Rousey left intact the rule that an IRA may be excluded from the bankruptcy estate only up to an amount that was reasonably needed for the individual and spouse to live on in retirement. BAPCPA now provides the answer to this remaining question.

NOTE : Under BAPCPA funds that are rolled over to an IRA from one of the above “qualified” retirement plans are excluded from the bankruptcy estate entirely. Because of this favored status, there may once again be good reasons for a participant to keep rollovers from retirement plans separate from their traditional IRAs and Roth IRAs and to not commingle such assets. Considering the maximum contribution amount for IRA’s has always been between $1,500 and the $4,000 current limit, the $1,000,000 limit set by BAPCPA for IRA assets will provide sufficent protection for these accounts for the foreseeable future.

State Law Versus Federal Law
State insolvency laws will still have a role to play in bankruptcy. Most states require that debtors can only claim the state’s exemptions plus those provided under other Federal laws, such as ERISA. Some states permit debtors to choose between exemptions provided under their laws and the Federal law. Therefore, in a situation where state law provides full or greater protection in excess of $1 million for a traditional IRA, the individual may still choose to apply the state bankruptcy provision. Obviously, this is a decision that should only be made with the advice of legal counsel.