Grant of security interest in IRA to broker/dealer not PT: lien inapplicable if in conflict with ERISA or Code

A grant of a security interest in the assets of an IRA by a debtor to the broker/dealer acting as IRA custodian was not a prohibited transaction under Code Sec. 4975(c)(1)(B) because it secured no actual lending obligation and by its terms was not applicable in the event of any conflict with ERISA or the Code, according to a U.S. Bankruptcy Court in Tennessee (BC-TN). Thus, the nearly $40,000 held in the debtor’s traditional and Roth IRAs remained exempt from her bankruptcy estate.

Several years before filing for bankruptcy, the debtor had opened a traditional and a Roth IRA with First Tennessee Brokerage, Inc., a subsidiary of First Tennessee Bank. As part of the application process the debtor signed “customer agreements” for each IRA that provided the broker/dealers with a security interest in the IRA assets in the event of indebtedness between the account holder and the broker/dealer.

Each agreement stated the lien provision would not apply “to the extent such application would be in conflict with any provisions of ERISA or the Internal Revenue Code” or related rules or guidance. In addition, according to the custodial agreements, the form of the IRAs complied with IRS Form 5305-A.


When the debtor filed for bankruptcy under Chapter 7 in 2012, the bankruptcy trustee argued that the two IRA accounts were not exempt from the bankruptcy estate under Bankruptcy Code Sec. 522 because the security interest granted to the broker/dealer was a prohibited transaction that stripped the accounts of their status as qualified IRAs under Code Sec. 408.


The court ruled in favor of the debtor. Though it acknowledged case law supporting the trustee’s argument, it emphasized that in this case the grant of security interest was operative only to the extent it did not conflict with ERISA or the Code. In addition, no actual loan ever took place.

Finally, the court took notice of IRS Announcement 2011-81. The IRS, noting the DOL’s intention to consider a new PT class exemption regarding security interests of this kind, stated it would grant temporary relief for IRA owners in circumstances similar to the debtor’s, providing no actual debt obligation had been incurred.

Source: In re James, Debtors (BC-TN).

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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