Variable annuity purchased with 401(k) rollover exempt from bankruptcy estate

A debtor was authorized under the Bankruptcy Code to exempt a variable annuity contract that had been purchased with funds rolled over from her 401(k) account, a Bankruptcy Court in New Jersey has ruled. The variable annuity constituted a qualified retirement annuity, for purposes of the exemption, because it was designed as an income substitute for wages.

Purchase of variable annuity with 401(k) rollover

Upon retirement, an employee rolled over the balance in her 401(k) account into a variable annuity contract maintained by an insurance company. Monthly payments under the annuity contract were to begin on the annuity start date, at which time the employee would be age 69. In addition, the annuity date, under the contract, could not be changed to a date later than April 1 of the calendar year next following the end of the calendar year in which the annuitant would reach age 70-1/2.

The employee was authorized to withdraw part or all of the amount in her investment account prior to the annuity starting date. However, a sales charge would be assessed on withdrawals made during the first seven years of the contract.

Subsequently, the employee filed for Chapter 7 bankruptcy relief and attempted to exempt the full value of the annuity under Bankruptcy Code Sec. 522(d)(10)(E). The bankruptcy trustee objected to the exemption, maintaining that the annuity was not a retirement annuity and was not part of a qualified retirement plan.

Bankruptcy Code Sec. 522(d)(10)(E) exemption

Bankruptcy Code Sec. 522(d)(10)(E) provides an exemption from the bankruptcy estate for payments (a) under a stock bonus, pension, profit-sharing, annuity or similar plan or contract, (b) made on account of illness, disability, death, age or length of service, (c) to the extent reasonably necessary for the support of the debtor and any dependents of the debtor. Thus, the exemption will not apply if the payment is made on account of age or length of service but the plan or contract does not qualify as an arrangement under Code Sec. 401(a), 403(a), 403(b), or 408.

In addressing what constitute a “similar plan or contract,” for purposes of the exemption, the U.S. Supreme Court has focused on plans that provide income that substitutes for wages earned as salary or hourly compensation (Rousey v. Jacoway, US Sup Ct (2005), 544 U.S. 320). Under this interpretation, plans covered by the exemption would provide an income substitute for wages and not merely operate as savings accounts.

Following the guidance set forth in Rousey, the Bankruptcy Court first concluded that the variable annuity at issue was designed to provide income as a substitute for wages. While the contract language did not specifically require the debtor to begin taking distributions in the year in which she turned 70-1/2, it did state that the annuity starting date could not be changed to a date later than the year in which she turned 70-1/2, thereby preventing payments from beginning later than that date.

Finally, in determining whether the annuity payments would be made on account of illness, disability, death, age or length of service, the court explained that Bankruptcy Code Sec. 522(d)(10)(E) does not prohibit debtors from having access to their funds. Rather, the exemption will continue to apply if a debtor’s right to access funds is limited in some significant way because of age. Accordingly, because withdrawals made by the debtor before age 59-1/2 would have been subject to the 10 percent penalty tax, and in the early years of the contract, she would have incurred a sales charge, access to the annuity was restricted on account of age and thus, was in compliance with the exemption.

Source: In re Kiceniuk (US Bank Ct NJ).

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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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