Single payment immediate annuity with fixed benefit payments funded by IRA rollover was exempt in bankruptcy

A single payment immediate annuity contract with fixed annuity payment benefits funded by a rollover from a traditional IRA was exempt under the U.S. Bankruptcy Code, according to the Bankruptcy Appellate Panel for the Eighth Circuit.

A debtor filed a Chapter 7 bankruptcy case and claimed an annuity as exempt property under section 522(b)(3)(C) of the U.S. Bankruptcy Code. The annuity was purchased in 2009, when the debtor was approaching his mid-60s, and was funded entirely from a tax-qualified IRA, which would have been exempt in bankruptcy.

Under the terms of the annuity contract, the insurance company was to make eight annual income payments to the debtor beginning in 2010. The debtor was allowed to make a single withdrawal of up to 75% of the withdrawal value (the present value of any remaining payments under the annuity contract). No additional purchase payments were permitted after the contract issue date. By its terms, the IRA agreement controlled in the event of a conflict between the annuity contract and the IRA agreement. The IRA agreement specifies that the entire interest of the annuity is nonforfeitable. While the IRA agreement states that tax penalties may apply to early withdrawals from the IRA, the IRA agreement does not itself impose an early withdrawal penalty on the debtor.

Bankruptcy exemption

Section 522(b)(3)(C) of the Bankruptcy Code exempts “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under sections 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” The Bankruptcy Court concluded that the funds at issue were held in an account that is exempt from tax under Code Sec. 408(b) as an “individual retirement annuity” and, as a result, the debtor could claim the funds exempt under the Bankruptcy Code. The bankruptcy trustee appealed, contending that the plain language of Code Sec. 408(b)(2)(A) and (B) require that an IR-annuity have flexible, annual premiums.

The annuity here had a single, fixed premium. The trustee contended that, since the annuity does not require yearly contributions by the debtor, who was of retirement age when the annuity was purchased, the rollover made the entire amount of the funds nonqualified. The bankruptcy appellate panel disagreed, finding that “commentators, legal forms based on the statute, and the IRA Agreement here all interpret the statute contrary to the Trustee’s position.”

IR-annuity retained tax advantaged status

An IR-annuity, the court noted, is an annuity contract issued by an insurance company to which the individual pays premiums instead of contributions. In order to obtain favorable tax treatment, a traditional IR-annuity must comply with Code Sec. 408(b). While the annuity contract here does not expressly state that it complies with Code Sec. 408(b) it states its intent to comply with that section. In addition, the IRA agreement specifically refers to Code Sec. 408(b) when discussing distributions and mentions Code Sec. 408 in the context of rollovers. If a rollover is properly made, the court said, the funds retain their tax-exempt status and thus their exemptability in bankruptcy cases. Although the annuity documents place on the debtor the ultimate responsibility for determining whether the annuity meets the applicable tax requirements, the documents clearly reflect an attempt to do so, the court found.

The court then considered whether the fact that the annuity did not permit additional annual premiums took it out of compliance with Code Sec. 408(b). The appellate court held that it did not. Reading the income limitations of Code Sec. 219(b), the court interpreted the statute not to say that annual premiums are required but that if there are annual premiums, they may not exceed the limits of Code Sec. 219(b)(1)(A). Rollover IRAs retain their tax advantaged status even though annual contributions are not required, the court observed. “We can conceive of no purpose served by requiring an annual premium in the case of a rolled-over IRA – no matter how de minimis – particularly where the owner is already old enough to withdraw funds for retirement without penalty,” the court stated. Accordingly, the Bankruptcy Appellate Panel affirmed the decision of the bankruptcy court.

Source: In re Joseph Matthias Miller (U.S. Bank. App. Pnl. 8th Cir.) .

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