How an Individual Retirement Account Can Lose Its Protection in Bankruptcy
Under the revisions to the Bankruptcy Code in 2005, individual retirement accounts (IRA’s) are exempt from attachment in a bankruptcy up to a specific dollar amount. Accordingly, those funds generally cannot be seized by the bankruptcy court or trustee, and used to pay your creditors. In New Jersey, IRA’s have broader protection as “excluded” assets. See NJSA 25:2-1(b). There may be circumstances or transactions, however, that could provide a trustee an opportunity to seize IRA funds.
Using Money from an IRA Rollover
Suppose that you have funds from one IRA that you want to roll over into another IRA. Under the law, you have 60 days to roll those funds over without incurring penalties or tax consequences. If you use those funds to pay for living expenses or other immediate needs, but replace them with income earned during the 60 day period, the trustee could argue that the rollover funds amounted to a savings account equivalent, and should, therefore, be accessible to creditors. There are reports that trustees have made this very argument, though no reported rulings yet on whether this attempt will be successful.
The best advice is not to use rollover funds for any purpose, unless you are prepared to lose them. You should place rollover funds in a separate account and leave them untouched until they are transferred to the new retirement account.
Making Fraudulent Transfers into Retirement Funds
The protection for IRA’s can be lost if contributions can be characterized as a “fraudulent transfer” used to evade payment of debts. There are annual limits to the maximum allowable tax free contributions thad can be made to such accounts. Exceeding those dollar amounts is a sure-fire way to attract assertions that the transfers were fraudulent to creditors. This could result in the loss of the protection IRA accounts enjoy.Inherited IRA accounts may not be protected.
When someone other than your spouse dies and has named you as the beneficiary of their IRA, one of your options is to transfer the funds into an “IRA Beneficiary Designated Account” or “IRA-BDA” account. There are major tax advantages to doing this. However, unlike a regular IRA, these funds are freely available without penalty. Several courts have recently held that these accounts are more like regular investment accounts and do not have the protection afforded to IRA’s. The question is still open in New Jersey, where New Jersey law has been held to extend extra protection to IRA’s created under specified sections of the Internal Revenue Code.
We are not tax advisers. These are matters that should be reviewed by a tax professional.
IRS CIRCULAR 230 DISCLOSURE: Pursuant to Treasury Regulations, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used or relied upon by you or any other person, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any tax advice addressed herein
Contact Neuner & Ventura, LLP
We understand the stress, anxiety and confusion that can be associated with a potential bankruptcy filing. We offer a free initial consultation to every client. For an appointment, call Neuner & Ventura at (856) 596-2828 or send us an e-mail. We do, however, reserve the right to charge a fee to review any work done by another attorney. Evening and weekend appointments are available upon request.
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