In my last post, I wrote about issues involving IRAs in bankruptcy cases. IRAs are a common retirement savings product and Congress and the Bankruptcy Courts have been consistent in giving retirement accounts protection from creditors in bankruptcy cases.
Like IRAs, 401(k) plans are common retirement accounts. And like IRAs Congress and the Courts have established general rules that exempt ERISA-qualified, defined-contribution accounts in bankruptcy cases. But just like IRAs, there are some situations that result in 401(k) accounts that can complicate the presumed protection of a 401(k).
There really isn’t much controversy involving 401(k)s in most circumstances. In 1992 the U.S. Supreme Court held in the Shumate case that 401(k) accounts were not property of the bankruptcy estate.
Congress re-wrote the Bankruptcy Code in 2005 and in Section 522(c)(3) provided that 401(k) accounts are exempt in their entirety as retirement funds. For emphasis, Congress added Section 522(d)(12) which also specifically exempts 401(k)s.
But that raises a question: before 2005 there wasn’t a specific exemption for 401(k)s – it was the Shumate Court’s holding that 401(k)s weren’t part of the estate that kept them out of harm’s way. So when Congress added the provisions exempting 401(k)s did that mean that this type of retirement account is part of a bankruptcy estate, just that it is exempt?
The reader can be forgiven for wondering why this is an issue. Either the 401(k) isn’t property of the estate or it’s a 100% exempt asset of the estate and so what difference does it make? The answer lies in the language of 522(c)(3). That’s the “catch-all” exemption for 401(k)s and it specifically exempts “retirement funds” held in 401(k)s. Then recall the inherited IRA case that I wrote about previously. The Supreme Court held that an inherited IRA is not exempt as an IRA since the person who inherits the IRA did not contribute to it, so it’s not that person’s “retirement fund.”
So what does that mean for 401(k)s that are transferred from the party that contributed to the 401(k) to another party? This happens a lot in divorce case property settlements. Does this mean that the 401(k) awarded to an ex-spouse who now files bankruptcy is now something the bankruptcy trustee can administer? Or is the Shumate case still in control, and 401(k)s are not property of a bankruptcy estate?
Right now, we just don’t know that answer – the case with these facts has not made it to the appellate courts for interpretation. If you’re a person thinking about filing a bankruptcy case and you have a 401(k) in your name that’s not from your own employer – it’s a very good idea to speak with an experienced attorney to determine your best course of action. At Kain & Scott our attorneys are waiting to help you! See us at www.kainscott.com.
