How protected are your clients' retirement accounts after the 2005 Bankruptcy Act?

• Author: Gans, Richard R.

Much ink has been spilled on how the 2001 federal tax act may, or may not, mean the end of the traditional estate planning practice as we have known it. Come what may from Congress in the form of estate tax legislation, one thing that will probably not change is that estate planning lawyers need to know a little about a lot of things. While the estate planning specialist may not always feel comfortable giving advice to be relied upon by the client in any particular case, it will not do, in client conferences, always to say: "I am not an expert in that area; we will have to get (the client hears 'pay') my partner or outside counsel to answer that question."

Over the past several years, clients seem to be paying closer attention to asset preservation, especially their retirement accounts. Even clients with no known or foreseeable creditors want assurances that their retirement accounts are safe from the "frivolous" lawsuits they read about in the newspapers and hear about in political speeches. They want to know what is "safer": an employer-sponsored plan or an IRA? The wide publicity given to Congress' enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 on April 20, 2005, has served to heighten interest in these and other related areas. Clients want to know if Congress, having moved to slay the federal estate tax dragon, has acted again as St. George to dispatch predatory creditors.

This article takes stock of the relevant state and federal law as it existed before the act in order to better understand the changes wrought, and not wrought, by it. We will continue by discussing the provisions of the act relevant to the exemption of IRAs and other retirement accounts from creditors' claims in the context of a federal bankruptcy proceeding. In Florida, these changes cannot be understood apart from state law; as it happens, the relevant state statutes recently have been amended, and we will discuss these changes. The article will conclude by identifying areas where the act may not be clear, and where questions may remain. (1)

The One Thing to Know About Federal and State Law Exemptions

If a retirement account (2) owner voluntarily seeks the protection of federal bankruptcy laws, or is involuntarily put into bankruptcy by his or her creditors, (3) the extent to which his or her retirement accounts are exempt is determined by federal law. On the other hand, if the retirement account owner is sued in state court, state law exemptions apply.

Under federal bankruptcy laws, both before and after the act, a debtor-in-bankruptcy generally can choose between exemptions available under the federal Bankruptcy Code (set forth in 11 U.S.C. [section] 522(d)) and those available under the law of the state in which the debtor resides. Federal law, however, gives the states the ability to require debtors to use state law exemptions in a federal bankruptcy proceeding. Florida has done just that: F.S. [section] 222.20 provides that "residents of this state shall not be entitled to use the federal exemptions in [section] 522(d) of the Bankruptcy Code...." Thus, in Florida, whether the issue is to be resolved in the federal bankruptcy court or state court, the heart of the matter is Florida's state law exemptions, which are largely set forth in F.S. Ch. 222.

Protection for Retirement Accounts Before the Act

* Accounts in Qualified Plans

In many instances, the protection afforded to accounts in "qualified" retirement plans (by which we mean, generally speaking, employer-provided plans covered by ERISA's fiduciary rules, as contrasted, generally speaking, with IRAs) before the act, and before the revisions to F.S. [section] 222.21 discussed below, frequently turned on the subtleties of ERISA or on the court's (usually the bankruptcy court's, but never the Tax Court's) determination as to whether the account was income tax exempt. Beginning on October 17, 2005, when the relevant provisions of the act took effect, exemption of retirement accounts will be analyzed differently.

The seminal pre-act case is Patterson v. Shumate, 504 U.S. 753 (1992). In that case, the U. S. Supreme Court concluded that a debtor's interest in a pension plan subject to Part 2 of Title I of ERISA was excluded from the debtor's bankruptcy estate under 11 U.S.C. [section] 541(c)(2), which excludes from the estate any beneficial interest of the debtor in a trust subject to a restriction on transfer enforceable under any applicable nonbankruptcy law. The Court noted that plan was subject to [section] 206(d)(1) of ERISA (29 U.S.C. [section] 1056(d)(1)), which requires any ERISA-qualified plan to provide that benefits under the plan cannot be assigned or alienated. The Court reasoned that the ERISA spendthrift provision was a "restriction on transfer enforceable under applicable nonbankruptcy law."

The Patterson decision had its limits. First, it only applied to pension plans covered in Part 2 of Title 1 of ERISA. Plans that might otherwise be thought of as "qualified plans" that cover only owners of corporations and partnership, but not employees, are not covered by Part 2 of Title 1 of ERISA. These plans are not required to have the "ERISA spendthrift clause" that covered the plan at issue in Patterson. Thus, a debtor's interest in a plan that covered owners, but not employees, could not be exempted from the bankruptcy estate; the interest was included in the estate and could be protected only if an exemption was available.

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