April 20, 2005

EMPLOYEE BENEFITS E-UPDATE

Ice Miller: New Bankruptcy Law - Good News for Tax Exempt Retirement Plans and Participants

The new bankruptcy law, signed by the President on April 20, 2005, provides broad protections for benefits under tax-exempt retirement funds. Basically, here is how the law will operate:

The new bankruptcy law will effectively pre-empt states from opting out of the "federal exemption list" relating to "tax-exempt retirement" funds. All retirement funds that are exempt from taxation under Internal Revenue Code Sections 401, 403, 408, 408A, 414, 457 or 501(a) will now be outside the reach of creditors. The debtor must demonstrate that the retirement benefits constitute payments on account of illness, disability, death, age or length of service, but the debtor will not have to prove they "are reasonably necessary" for the support of the debtor or the debtor's dependents. There is also a requirement to prove the tax-exemption of the retirement fund which may be done with a copy of the determination letter or other reasonable means.
However, the new law imposes a statutory cap for IRA accounts under Code Sections 408 and 408A (determined without regard to rollover amounts) of $1.0 million. The cap does not apply to a SEP under Code Section 408(k) nor simple retirement accounts under Code Section 408(p). In addition, the bankruptcy court may waive the cap to the extent "the interest of justice so requires."
Under existing federal bankruptcy law, there is a "federal exemption list." Debtors may exempt from their bankruptcy estate either (1) the federal exemption list, or (2) property exempt under non-bankruptcy federal law (e.g., ERISA), state and local law, and jointly owned property that is exempt under non-bankruptcy law. However, states may opt-out of the "federal exemption list" so that only the exemptions under (2) apply (most states have opted out).

For a more detailed analysis of the bankruptcy law as it relates to retirement plans, refer to the attached legal memorandum.

For additional information, please call or e-mail your contact in the Employee Benefits Group at Ice Miller.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.