K&E 33936875.1

REPORT ON RETIREMENT AND OTHER TAX-FAVORED ACCOUNT TREATMENT IN CHAPTER 7

AND 13 PERSONAL BANKRUPTCIES

TAX COMMITTEE

NATIONAL BANKRUPTCY CONFERENCE, NOVEMBER 2014

I. INTRODUCTION

When a debtor files for bankruptcy, all of the debtor’s property generally is included in

the bankruptcy estate. In chapter 7, assets are subject to liquidation in satisfaction of creditors’

claims; in chapter 13, debtors generally maintain their assets, subject to a multi-year payment

plan whose contours depend, in part, on the debtors’ assets, including their disposable

postpetition income.1

Certain categories of assets—many of which apply only in individual bankruptcies—are

entirely excluded from a debtor’s estate,2 while personal debtors are able to exempt certain assets

generally considered necessary to support debtors’ basic needs.3

Assets in certain retirement accounts and benefit plans, tax-advantaged accounts, and

social security benefits receive substantial exclusions and exemptions under various provisions

of the Bankruptcy Code. These protections were expanded for certain tax-advantaged accounts

by the Bankruptcy Abuse and Consumer Protection Act of 2005 (“BAPCPA”).4

This report summarizess the current state of exclusion and exemption of retirement and

tax-advantaged accounts in chapter 7 and 13 and highlights certain key issues. In particular, the

following principal issues merit further consideration and perhaps future regulatory or statutory

action:

1. To what extent should a tax-exempt retirement asset lose its bankruptcy-exempt

status when the asset loses its tax-exempt status, and why should a distinction exist between

assets in an ERISA plan and individual retirement assets?

2. How should retirement assets inherited from a spouse be treated?

1 The Tax Committee greatly appreciates the assistance of Anthony Sexton of Kirkland & Ellis LLP in the

preparation of this report. The idea of this report began with an outline prepared by NBC member Tara Twomey in

connection with a panel presentation at the National Conference of Bankruptcy Judges. Tara’s outline played a key

role in preparing this report.

2 11 U.S.C. § 541(b).

3 11 U.S.C. § 522. A debtor can elect either the applicable state or federal exemptions, unless the debtor’s state of

domicile has “opted out” of the federal exemption regime. Importantly for the purposes of this report, however,

debtors may benefit from BAPCPA’s retirement account exemption provisions without regard to state exemptions.

4 Pub. L. 109-8, 119 Stat. 23 (April 20, 2005).

2 K&E 33936875.1

3. How should retirement assets be treated in a Chapter 13 case? More specifically,

when should different types of retirement income qualify as “regular income,” “current monthly

income,” and “disposable income?”

4. What type of pre-bankruptcy planning should a debtor be permitted to accomplish

using retirement plan assets? In particular, what type of objective standards should apply to

determine when a debtor engaged in a fraudulent conveyance pre-bankruptcy in order to exclude

assets from the bankruptcy estate?

5. Why are Health Savings Plans, educational individual retirement accounts,

Coverdell accounts, and other types of similar accounts subject to disparate treatment under the

Bankruptcy Code?

II. EXCLUSIONS AND EXEMPTION FROM DEBTORS’ ESTATES

Section 541(a) of the Bankruptcy Code generally includes all of a debtor’s property

interests, broadly defined, in the debtor’s estate. Other provisions of section 541, in turn,

exclude assets from the estate entirely; provisions of section 522 exempt property that is

otherwise included in the debtor’s estate under section 541. Therefore, it is necessary to look at

both Section 541 and 522 to see the full scope of exemptions for retirement assets.5

A. Exclusion Pursuant to Section 541(c)(2).6

Section 541(c)(2) excludes from a debtor’s estate property that is subject to a “restriction

on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable

nonbankruptcy law.” The prototypical example of an asset excluded from a debtor’s estate

pursuant to section 541(c)(2) is a “spendthrift trust” created pursuant to state law for asset

protection purposes. Spendthrift trusts need not have any retirement purpose. They are often

formed in connection with estate planning.

5 In addition to the exclusions and exemptions discussed below, BAPCPA enacted section 541(b)(7) of the

Bankruptcy Code, which provides that any amount withheld by an employer, or received by an employer from an

employee, for payment as contributions to certain tax-benefitted plans or in connection with state-regulated health

insurance plans, are excluded from a debtor’s estate. The scope of the provision is uncertain—debtors could

potentially argue that the broad language permanently permanently excludes any amounts withheld or received, even

after such amounts are subsequently distributed to a debtor—and it is unclear how courts will eventually resolve

such an argument. Other than that, the exclusion is largely duplicative of other exclusions and exemptions, except

with respect to the “hanging paragraph” that has significant chapter 13 implications that are discussed below.

Notably, courts have held that section 541(b)(7) does not apply to the triple tax-advantaged vehicle known as a

health savings account.

6 In addition to the exclusion for ERISA plans discussed below, retirement funds established by a fairly wide variety

of federal statutes are also excluded from the bankruptcy code pursuant to anti-alienation provisions contained in the

applicable statute. See 42 U.S.C. § 407(a) (social security benefits); 38 U.S.C. § 5301(a)(1) (veteran’s benefits); 45

U.S.C. § 231m(a) (benefits under the Railroad Retirement Act); 5 U.S.C. § 8346 (benefits under the civil service

program for federal employees); 5 U.S.C. § 8437(e) (amounts in the thrift savings plan, essentially the federal

equivalent of a 401(k)). Considerations for most of these programs are similar, but not identical, to considerations

for ERISA benefits, though certain of these provisions afford protection for any post-distribution funds that are

traceable to these benefit sources, resulting in much broader protection.

3 K&E 33936875.1

After the enactment of the Bankruptcy Code, there was significant disagreement in the

case law with respect to whether section 541(c)(2) could apply to accounts and assets that are not

state law spendthrift trusts, particularly in the context of plans governed by the Employment

Retirement Income Security Act (“ERISA”). This conflict was definitively decided by the

Supreme Court in Patterson v. Shumate, which held that the anti-alienation provisions in ERISA

qualify as “applicable nonbankruptcy law” under section 541(c)(2).7 As a result of Patterson,

assets in “ERISA-qualified” plans are generally excluded from a debtor’s estate.

1. ERISA Plans.

As a general rule, assets that are held in “ERISA-qualified” plans, as that term was used

in Patterson, are excluded from debtors’ bankruptcy estates. Importantly, the clear majority rule

appears to be that assets are only protected while they are in ERISA plans. If the assets are

distributed to the debtor, they are no longer held in trust and, therefore, no longer protected under

section 541(c)(2), though they may be protected by other applicable exclusions or exemptions.8

The minority rule appears to provide that post-retirement distributions made in accordance with

the terms of the plan are protected, but that position is more appropriate in the context of other

exclusions and exemptions, rather than the exclusion under section 541(c)(2).9

a. General Rule: ERISA Anti-Alienation Protection.

The protection afforded to ERISA plans covered by Patterson is broad. First, assets in

ERISA plans are excluded in an unlimited amount. This contrasts sharply with the rule for

regular tax-qualified accounts, where there is a monetary limit of approximately $1.2 million

under applicable federal exemptions (discussed later). There is no requirement that the amounts

be “reasonably necessary for the support of the debtor,”10 no cap on the amount protected by the

exclusion,11 and no requirement that payment from the trust be associated with any particular

event, such as retirement, age or disability, or that there be a penalty for an early withdrawal.12

7 Patterson v. Shumate, 504 U.S. 752 (1992)

8 See, e.g., N.L.R.B. v. HH3 Trucking, Inc., 755 F.3d 468 (7th Cir. 2014) (collecting majority cases, holding

distributed benefits not protected).

9 See U.S. v. Smith, 47 F.3d 681 (4th Cir. 1995) (holding in criminal restitution context that post-retirement

distributions protected by anti-alienation provisions, but early withdrawals were not; overturned by statute in the

case of restitution).

10 Contrast with 11 U.S.C. § 522(d)(10)(E) (exempting payments under certain plans on account of illness,

disability, death, age, or length of service to the extent “reasonably necessary for the support of the debtor and any

dependent of the debtor).

11 Contrast with 11 U.S.C. § 522(n) (limiting exemption forassets in individual retirement accounts under IRC § 408

and 408(A), other than simplified employee pensions under IRC § 408(k) and simple retirement accounts under IRC

§ 408(p), to a statutory cap of approximately $1.25 million (subject to periodic adjustment)).

12 See, e.g., In re McBride, 347 B.R. 585, 591-93 (Bankr. S.D. Tex. 2006) (collecting cases from multiple

jurisdictions and holding that all property in ERISA plan, including after-tax contributions that could be withdrawn

without penalty, were excluded from estate).

4 K&E 33936875.1

Second, under the majority view, the protection for ERISA assets cannot be lost under

circumstances that would cause other exclusions to become inapplicable. Most notably, assets

held in a retirement plan subject to ERISA can maintain their bankruptcy-exempt status even if

such plan engages in activities that cause such plan to violate ERISA. Thus, for example, the

majority rule provides that this exclusion applies even if the ERISA plan violates the IRC’s

tax-qualification provisions,13 even where the debtor or an insider of the debtor committed bad

acts.14 These cases rely on the proposition that there is no equitable exception to ERISA’s

anti-alienation provision.15 The minority view, by contrast, holds that if an ERISA plan is no

longer tax-qualified because of a debtor’s actions, the ERISA plan can lose the benefit of the

exclusion and become property of the debtor’s estate.16

The minority view does not seem consistent with the Supreme Court’s clear language in

Guidry, although it does have some sound policy justifications to support it. First, it does not

seem that an exclusion should apply to assets when a debtor has committed bad acts. Second,

the minority rule also adheres more closely to the paradigm of state law spendthrift trusts; under

state law, a spendthrift trust’s anti-alienation provisions will fail if the trust is abused or, in most

cases, if the debtor controls the trust’s assets. Third, the minority rule does seem more consistent

with the approach adopted in BAPCPA’s exemptions for retirement accounts. Indeed, as

discussed below, BAPCPA’s retirement plan exemptions (as contrasted with the section

541(c)(2) exclusion) essentially implement a harsher version of the minority rule.

b. Circumstances Where ERISA Protection Under Section 541(c)(2)

Does Not Apply.

i. Plans Excluded From ERISA.

Certain kinds of retirement plans are simply not covered by ERISA. There are a few

primary examples of this: owner/spouse plans, government-sponsored plans, individual

13 See, e.g., In re Sewell, 180 F.3d 707, 712 (5th Cir. 1999) (quoting In re Baker, 114 F.3d 636, 638 (7th Cir. 1997)

(observing that reference in Patterson to an “ERISA-qualified” pension plan was likely intended to refer to a plan

“covered by Subchapter 1 of ERISA” and holding that ERISA plan that was no longer tax-qualified remained

exempt from a debtor’s estate)); In re Meinen, 228 B.R. 368, 382 (Bankr. W.D. Pa. 1998) (concluding that plan

governed by ERISA was exempt regardless of whether plan was also tax-qualified, before determining, for the

avoidance of doubt, that plan was tax-qualified); In re Bennett, 185 B.R. 4 (Bankr. E.D.N.Y. 1995) (plan “ERISA-

qualified” under Patterson so long as the plan is governed by ERISA and includes an enforceable anti-alienation

provision).

14 See, e.g., In re Handel, 301 B.R. 421, 425-29 (Bankr. S.D.N.Y. 2003) (holding that law firm partner’s interest in

an ERISA profit-sharing plan was exempt from the bankruptcy estate despite the fact that the partner, among other

things, represented that he was a trustee of the ERISA plan when he was not and withdrew plan assets to pay

personal debts).

15 See, e.g., Handel, 301 B.R. at 433-34 (collecting cases, quoting Guidry v. Sheet Metal Workers Nat. Pension

Fund, 493 U.S. 365 (1990) (holding no generalized equitable exception to ERISA anti-alienation provision even in

cases of embezzlement from a union, rather than the union’s ERISA pension plan)).

16 See, e.g., In re Goldschein, 244 B.R. 595, 602 (Bankr. S. Ma. 2000) (holding that debtor’s bad acts resulted in

ERISA plan being included in debtor’s estate); In re Lawrence, 235 B.R. 498, 508 (Bankr. S.D. Fla. 1999) (same);

In re Harris, 188 B.R. 444, 449 (Bankr. M.D. Fla. 1995) (same).

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retirement accounts (“IRAs”), simplified employee pension plans (“SEPs”),17 and certain stock

option plans.18

ERISA only covers “employee benefit plans.” As a result, “plans where the only

participant is also the sole owner of the plan’s corporate structure” do not qualify as ERISA

plans.19 This exclusion from ERISA protection also applies where the only “employees” are the

owner and a spouse or the partners of a partnership.20 The presence of a single additional

participating employee will qualify the account for ERISA protection.21

Courts have held under a variety of factual circumstances that stock option plans are not

ERISA plans.22 29 U.S.C. § 1002(2)(A) provides that an “employee pension benefit plan” either

provide retirement income or defer income beyond the termination of employment. Regulations

promulgated by the Department of Labor provide that certain severance and bonus programs are

not qualified ERISA plans for these purposes.23 Courts analyzing stock option plans have held

that the plans did not satisfy ERISA requirements where there has been no formal opinion issued

by the Department of Labor that a plan is an ERISA plan, the documentation does not establish

an ERISA plan, and the factual circumstances indicate that the funds are not intended to be

retirement funds or deferred funds because, for example, funds are available on demand.

17 Established pursuant to 26 U.S.C. § 408(k).

18 Before BAPCPA was enacted, even if these plans did not qualify for exclusion under section 541(c)(2), many of

these plans qualified for exemptions for retirement accounts under state law and under section 522(d)(10)(E) of the

Bankruptcy Code. Following BAPCPA, many of these accounts are now subject to federal exemptions that apply

regardless of state law. Exemptions are discussed in more detail below, but exclusion has different consequences,

and is generally (but not always) more favorable, than exemption, so the distinction maintains some relevance.

19 See, e.g., In re Bauman, 2014 WL 816407 (Bankr. N.D. Ill. Mar. 4, 2014) (holding that plan was not excluded

from estate because it was not a qualified ERISA plan, and no exemptions under state or federal law applied because

it was not a “retirement” plan) (citing In re Lowenschuss, 171 F.3d 673, 680-81 (9th Cir. 1999)); Meiszner v.

Suburban Bank & Trust Co., 397 F.Supp.2d 952, 655-56 (N.D. Ill. 2005) (plan not ERISA plan even though ERISA

qualification lost based on an employee leaving the company).

20 See 29 C.F.R. § 2510.3-3(c).

21 See Yates v. Henson, 541 U.S. 1, 12 (2004) (holding that working owners may enjoy ERISA protection so long as

one non-owner employee participates in plan).

22 See, e.g., Maguire v. Medtronic, Inc., 2010 WL 744561 (Bankr. W.D. Pa. Feb. 26, 2010) (employer stock option

plan that vested immediately and did not defer compensation not subject to ERISA); In re Segovia, 404 B.R. 896,

917-922 (N.D. Cal. 2009) (collecting cases, noting that the existence of an ERISA plan is a fact-intensive inquiry,

and concluding that stock option plan was not an ERISA plan because it did not have a retirement purpose, there

was no formal paperwork establishing an ERISA plan in line with Department of Labor guidance, and all stock

options vested significantly before retirement date).

23 29 C.F.R. § 2510.3-2(b)-(c).

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ii. Unfunded ERISA Plans.

At least one court has held that unfunded ERISA plans, such as unfunded key employee

plans or “top-hat” plans for highly compensated employees, do not have enforceable

anti-alienation provisions for the purposes of section 541(c)(2).24 This rule seems reasonable: if

the anti-alienation provision is not enforceable against an employer’s creditors—a point that is

generally made clear in plan documents—then there is no reason to afford debtor-employees

greater protection.25 In other words, if an employee can be divested from a plan’s assets because

of the bankruptcy of the employer, the employee certainly should be divested of those assets

because of the employee’s bankruptcy.

iii. BAPCPA Retirement Funds Exemptions.

BAPCPA amended section 522 to provide that, regardless of whether federal or state

exemptions are being applied, a debtor may exempt “retirement funds to the extent that those

funds are in a fund or account that is exempt from taxation under section 401 [relating to

qualified retirement plans], 403 [tax-favored annuities], 408 [traditional IRAs], 408A [Roth

IRAs], 414 [multi-employer benefit plans], 457 [plans with respect to government and certain

exempt organizations], or 501(a) [tax-exempt organizations] of the [IRC].”26

The exemption for IRAs and Roth IRAs, with the exception of “simplified employee

pension[s] under section 408(k) of [the IRC] or a simple retirement account under section 408(p)

[of the IRC]” is capped at $1,245,475. This cap excludes rollovers from certain other tax-

qualified accounts, but does not exclude rollovers from IRA accounts (in other words, a debtor

cannot work around the IRA cap by rolling over funds from one IRA into another IRA). The

exemption “may be increased if the interests of justice so require.”27

There are two key issues under the BAPCPA exemptions. The requirement of tax

qualification highlights the fact that exclusion under section 541(c)(2), where it applies, remains

more beneficial than BAPCPA’s exemptions. The second is the term “retirement funds.”

24 See, e.g., In re Jokiel, 453 B.R. 743, 751-52 (Bankr. N.D. Ill. 2011) (“[T]he Supplemental Plan is not a ‘qualified’

ERISA plan. While 29 U.S.C. § 1103 imposes a trust on plan assets and 29 U.S.C. § 1051, restricts the assignment

or alienation of plan benefits, neither of those provisions applies to ‘a plan which is unfunded and is maintained by

an employer primarily for the purpose of providing deferred compensation for a select group of management or

highly compensated employees,’ and therefore neither provision applied to the Supplemental Plan. 29 U.S.C. §§

1051(2), 1101(a)(1). Therefore, [Patterson] is easily distinguishable.”).

25 See IT Group Inc. v. Bookspan (In re IT Group Inc.), 448 F.3d 661 (3d Cir. 2006) (noting that unfunded ERISA

plan assets subject to claims of employer’s creditors).

26 11 U.S.C. § 522(b)(3)(C) (where state-law exemptions are otherwise applicable); (d)(12) (where federal

exemptions are applicable).

27 It is difficult to ascertain the circumstances under which the interests of justice would require an exemption be

increased beyond the already-generous cap.

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iv. Tax Qualification.

Each of the BAPCPA retirement account exemptions tie into tax-exempt qualifications

under the IRC. This is in significant contrast to the majority rule under section 541(c)(2) that

tax-qualification is not necessary for exclusion so long as there is an enforceable anti-alienation

provision. Before BAPCPA, many states had exemptions that depended on an account’s tax-

exempt status.

There are a number of circumstances that can result in an account losing its tax-exempt

status. Since BAPCPA was enacted, the reported cases have mostly addressed whether IRAs

have lost their tax-exempt status. 26 U.S.C. § 4975 enumerates a laundry list of prohibited

transactions, generally focused on improper withdrawals and uses of funds involving

“disqualified persons,” that will cause an IRA to lose its tax exempt status.28 Various courts

have analyzed whether the BAPCPA exemptions, and pre-BAPCPA state-law exemptions

applicable to tax-exempt plans, were inapplicable because of disqualified transactions.

Ultimately, these analyses are fact-intensive and case-specific.29

To qualify for the BAPCPA exemptions, an account must either be tax exempt (and have

a favorable tax ruling from the IRS) or the debtor must satisfy section 522(b)(4)(B)(i)-(ii).

Under section 522(b)(4)(A), a plan is presumed to be tax-exempt if there is a favorable ruling

from the IRS that is in effect on the petition date.30 This presumption can be rebutted based on

events or acts that occur after the IRS issues its determination.31

In the absence of a favorable determination, the debtor must demonstrate that the IRS has

not issued a negative determination, and (a) the plan is in substantial compliance with the IRC or

(b) the lack of compliance is “not materially responsible for that failure [i.e., it isn’t the debtor’s

28 See 26 U.S.C. § 408(e)(2)(A) (providing that engaging in transactions prohibited by IRC § 4975 will cause an

account to lose its tax-qualified status).

29 See, e.g., In re Cherwenka, 508 B.R. 228 (Bankr. N.D. Ga. 2014) (analyzing various exemptions, concluding that

one IRA was exempt because a debtor’s evaluation of investment options for the IRA and early withdrawals did not

constitute disqualifying transactions, but an annuity was not exempt because it was funded with lump-sum payments

that exceeded the annual statutory maximums under IRC § 408); In re Williams, 2011 WL 10653865 (Bankr. E.D.

Cal. June 3, 2011) (holding that an IRA was not exempt because debtor, who was IRA fiduciary, provided

development services with respect to a parcel of land owned by the IRA and a 401(k) was not exempt because there

was no “adopting employer” as required by 26 U.S.C. § 401, but another 401(k) was exempt); In re Ludwid, 345

B.R. 310 (Bankr. D. Colo. 2006) (holding that account was not a qualifying IRA for the purposes of state-law

exemption because of excess contributions and the fact that the accounts were improperly transferrable).

30 11 U.S.C. § 522(b)(4).

31 See, e.g., In re Richey, 2011 WL 4485900, *2 (9th Cir. B.A.P. Aug. 8, 2011) (noting that courts may evaluate

whether post-determination acts have deprived an account of tax-exempt status, but holding that no evidence had

been produced to rebut the presumption that exemptions are valid) (citing In re Plunk, 481 F.3d 302 (5th Cir. 2007)

(analyzing pre-BAPCPA state-law exemption under Texas law that applied to plans that were qualified under IRC

and holding that court could disregard outdated IRS determination where prohibited transactions were executed

following IRS determination)); Willis v. Menotte, 2010 WL 1408343, *5-6 (S.D. Fla. Apr. 6, 2010), aff’d 424 Fed.

Appx. 880 (11th Cir. 2011) (holding that presumption not rebuttable and concluding that prohibited withdrawals had

eliminated the account’s tax-exempt status).

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fault].”32 Notably, section 522(b)(4)(B) provides that funds “are exempt from the estate” if the

provision is satisfied. Accordingly, the exemption should apply even where the account is not

tax-exempt if 522(b)(4)(B)(ii) is satisfied.

A fundamental question is why is tax exemption a requirement under an IRA or Roth

IRA account, but not a requirement to a retirement account under an ERISA plan? Put

differently, why should the assets of an individual in a 401(k) account be exempt in bankruptcy

even if the 401(k) plan is maintained in contravention of ERISA requirements, whereas an IRA

account held by a debtor loses its bankruptcy-favorable status when the IRA loses its tax-exempt

status (in the absence of any other applicable state or federal exemption)? The presumed

explanation is that a debtor who has an asset held in an ERISA-qualified plan is not normally the

party responsible for maintaining the qualification of a 401(k)-type plan, whereas an IRA or

Roth IRA is more traditionally a debtor-owned and controlled asset, where the debtor himself or

herself has caused the failure of the tax-exempt status. This answer is satisfying in general, but

what is troubling is that many of the cases in this area involving ERISA-qualified plans clearly

involve a debtor who was in fact “in charge of” the plan and thus was a responsible party for the

actions that may have disqualified the plan. As a result, one sensible change to rationalize the

law in this area might be to either (i) provide that the exempt status of an ERISA plan can be

forfeited if the debtor has acted negligently so as to cause the ERISA plan to cease to be tax-

qualified under ERISA, or (ii) loosen the standards for IRA and Roth IRA accounts to provide

that such accounts are exempt so long as the debtor has in fact sought in good faith to maintain

his or her account in a tax compliant manner.

v. “Retirement Funds.”

As a textual matter, the BAPCPA exemptions apply only to “retirement funds” that are in

tax-exempt accounts. A split of authority was recently addressed by the Supreme Court in

holding that inherited IRAs are not exempt under the BAPCPA retirement account exemptions.33

The Supreme Court’s decision focused on the different attributes of inherited IRAs compared to

other retirement accounts, as well as the fact that the funds simply are not held for retirement

purposes.

Creditors could argue that the Supreme Court’s decision leaves the door open to litigation

asserting that funds in a “retirement account” will not actually be used for retirement purposes

and, therefore, should not be exempt. That will be a hard argument to win. In Clark, the parties

agreed that there should be an objective inquiry, under which “courts should not engage in a

case-by-case, fact-intensive examination into whether the debtor actually planned to use the

funds for retirement purposes as opposed to current consumption. Instead, we look to the legal

characteristics of the account in which the funds are held, asking whether, as an objective matter,

the account is one set aside for the day an individual stops working.”34 This language arguably

forecloses any analysis into the likely, or even subjectively anticipated, use of the funds.

32 11 U.S.C. § 522(b)(4).

33 See Clark v. Rameker, 134 S.Ct. 2242 (2014).

34 Id. at 2246.

9 K&E 33936875.1

Although an aggressive litigant could argue that a subjective inquiry is appropriate and a fully

objective inquiry was applied in Clark only because the parties agreed to apply that standard, the

language in the decision, along with the Supreme Court’s previous decision in Rousey (discussed

below), imply that the objective approach is the right one.

A narrower question is whether tax-exempt accounts that are inherited by a spouse can be

exempted. A spouse, unlike the daughter in Clark and other relationships in general, has the

option of rolling an inherited IRA into his or her own IRA, at which point the IRA is subject to

the same rules as other IRAs.35 The likely conclusion is that such rolled-over accounts will be

exempt given Clark’s focus on the legal characteristics of the account. The one problem is the

initial language in Clark that the BAPCPA exemption applies to “sums of money set aside for

the day an individual stops working.” An aggressive litigant could argue that an inherited IRA in

the hands of a spouse, like the one in the hands of the daughter in Clark, are not “objective set

aside for [the spouse’s] retirement.” The inheriting spouse did not set the money aside—the

deceased spouse did—and the funds were objectively set aside for the deceased spouse’s

retirement, not the inheriting spouse’s retirement. The fact that a married couple likely intended

to provide for their joint retirement could be considered a “subjective fact” that is off-limits

under Clark’s objective approach. Notwithstanding that potential argument, the tax code itself

recognizes that a spouse inheriting a retirement account is different by allowing the spouse to roll

the amount into his or her own account, and the law specifically acknowledges the importance of

spousal rights in retirement accounts by providing that qualified domestic relations orders are an

appropriate exception to anti-alienation principles. Accordingly, the better position is almost

certainly that if a spouse rolls an inherited retirement account into his or her personal account,

the funds are exempt.36

What if the spouse doesn’t wish to roll the IRA account over into his or her own IRA?

Seemingly under Clark, the IRA in that case would again not be “retirement funds” and thus

would not qualify as bankruptcy exempt. Candidly, however, we are not sure that should be the

answer. To be sure, the fact that a surviving spouse could roll over an IRA account into their

own IRA account can be interpreted to mean that the surviving spouse has a solution to this

problem. If he or she chooses not to use that solution, then so be it. But alternatively, it is often

the case that this IRA was set aside for the retirement of both spouses. What’s more, it is not

uncommon for a working spouse to fund the IRA of a non-working spouse (or a spouse with

employment that would not otherwise provide sufficient funds to contribute to a retirement plan).

Moreover, it is often the case that the premature death of a spouse surely leaves the surviving

35 See Tres. Reg. 1.408-8 (providing for spousal rollovers); 26 U.S.C. § 408(d)(3)(C)(providing that a non-spouse

cannot roll over an inherited account). [NTD: One thing that I thought about including but did not is the question

of whether a gay married couple who has moved to a state that does not recognize gay marriage would be able to

roll the IRA over and, therefore, avoid the implications of Clark. I think it’s an interesting question but assumed it

better not to include in this context.]

36 The exemption laws of some states apply to inherited retirement accounts or there are cases interpreting the

exemptions in a way that would likely apply the exemption to an inherited account. See, e.g., Alaska Stat. §

09.38.017; Ariz. Rev. Stat. § 33-1126(B); Fla. Stat. § 222.21; Idaho Code. § 55-1011; Mo. Rev. Stat. § 513.430.1;

N.C. Gen. Stat. § 1C01691(a)(9); Ohio Rev. Code. § 2329.66(A)(10); S.C. Code § 15-41-30; Tex. Prop. Code §

42.0021; see also K.S.A. § 60-2308 (providing that all plans and IRAs are conclusively presumed to be spendthrift

trusts); N.Y. C.P.L.R. § 5205(c) (same).

10 K&E 33936875.1

spouse in a more difficult situation. Indeed, in many cases, it may be the death of the spouse that

causes the bankruptcy filing in the first case. As a result, at least so long as the surviving spouse

does not withdraw the funds from the IRA account, an argument can be made that Clark should

not automatically apply to the surviving spouse. As an aside, that outcome seems consistent with

the general contours of the estate tax, where a married person is permitted to transfer essentially

all of his or her assets to their spouse without triggering any estate tax. The estate tax essentially

waits until both spouses have passed away before its imposition, under the theory that marital

assets are, regardless of title, joint assets.

III. CHAPTER 13 CONSIDERATIONS OF EXEMPT OR EXCLUDED ASSETS

To be eligible for chapter 7, a debtor must demonstrate that filing under chapter 7 is not

abusive. Post-BAPCPA, that analysis requires a mechanical evaluation of a debtor’s sources of

income and expenses compared to certain statutorily-defined cutoffs. If a debtor is not eligible

for chapter 7, or if the debtor prefers to avoid turning over his or her non-excluded/exempt

assets, the debtor will file for chapter 13.37 The defining characteristic of chapter 13 is a multi-

year debt repayment plan that requires the application of all of a debtor’s “projected disposable

income” to pay creditors.38 There is a significant degree of division among courts about how

excluded and exempt retirement plan assets are treated for eligibility and plan confirmation

purposes, and particularly the extent to which they qualify as projected disposable income.

A. Eligibility Implications of Retirement Assets.

For a debtor to be eligible for chapter 7, they must satisfy a mechanical “means test” that

serves to shift individuals with the perceived ability to pay creditors from chapter 7 to chapter

13. For a debtor to be eligible for chapter 13, the debtor must, among other things, have “regular

income” and satisfy certain other requirements. There are multiple inconsistencies in the case

law with respect to how exclusions and exemptions for retirement assets interact with these tests.

1. Chapter 7 Eligibility: Current Monthly Income and the “Means Test.”

A chapter 7 case must either be dismissed or converted to chapter 11 or chapter 13 where

a debtor’s debts are primarily consumer debts if a court, after notice and a hearing, “finds that the

granting of relief would be an abuse of the provisions of [chapter 7].”39 BAPCPA implemented

a means test, based principally on “current monthly income” compared to statutorily-identified

expenses,40 that provides for a presumption of abuse if the means test, or an income-based safe-

37 Or, in rare circumstances, individual chapter 11 (which also applies to certain individuals that are not eligible for

chapter 13). Chapter 11 is generally beyond the scope of this paper.

38 See 11 U.S.C. § 1325(b)(1). This requirement applies only if a creditor or the trustee objects to a plan that does

not pay creditors in full.

39 11 U.S.C. § 707(b).

40 Many of these expenses are based on expenses that are factored into levy procedures under the IRC.

11 K&E 33936875.1

harbor, are not satisfied.41 “Current monthly income” is broadly defined to include “income

from all sources that the debtor receives (or in a joint case the debtor and the debtor’s spouse

receive) without regard to whether such income is taxable, derived during [a 6-month measuring

period.]”42 The inclusion of both “received” and “derived” makes it very unclear if income that

is earned before the 6-month period but received during the 6-month period is included. There is

a split of authority on the issue.43

Although it is not entirely clear, it appears that excluded and exempt assets, with the

exception of social security benefits, are considered “current monthly income.”44 Social security

benefits are explicitly excluded, though it is not clear whether courts have the authority to

consider social security benefits when considering whether a filing is abusive pursuant to section

707(b)(3)—the better rule is arguably that Congress has clearly expressed that social security

benefits should not be “held against” a debtor for these purposes.45

There is also a split in authority with respect to whether distributions from retirement

accounts are “income.” Some courts have held that retirement account contributions are properly

treated as income at the time the contribution is made, rather than when a distribution is made.

These courts reason that distributions are akin to withdrawals from a savings account of

previously-earned income, or to the “sale” of an investment asset.46 At least one court also felt

41 The presumption of abuse can be rebutted if a rigorous showing of special circumstances is satisfied, and even if

the presumption does not arise, the court can consider if the filing is an abuse of chapter 7. See 11 U.S.C. §

707(b)(3) (“In considering. . . whether the granting of relief would be an abuse of the provisions of this chapter in a

case in which the presumption [under the means test] does not arise or is rebutted, the court shall consider (A)

whether the debtor filed the petition in bad faith; or (B) the totality of the circumstances . . . of the debtor’s financial

situation demonstrates abuse.”). The extent to which a court could properly conclude that a chapter 7 filing is

abusive based on “means testing-like” considerations even if the debtor satisfies the express means test is unclear.

42 11 U.S.C. §101(10A).

43 See, e.g., In re Miller, 2014 WL 5018464 (10th Cir. B.A.P. Oct. 8, 2014) (holding that all income received during

the six-month period is included, regardless of when it is earned); In re Strickland, 504 B.R. 542, 545-46 (Bankr. D.

Minn. 2014) (holding that only income earned during the six-month period is included, regardless of when the

income is received); In re Arnoux, 442 B.R. 769 (Bankr. E.D. Wash. 2010) (holding that income must be both

received and earned during six-month period). The Strickland position seems clearly wrong. Collier adopts the

Arnoux view. See Collier on Bankruptcy (16th Ed. 2014), ¶101.10A (“The better interpretation is that if income is

derived from an earlier period it should not be included. Otherwise, there would be no purpose to including both

‘received’ and ‘derived’ in the definition.”). Miller’s interpretation of the word “derived” is a reasonable, but

somewhat technical grammatical parsing that largely reads “derived” out of the statute. Overall, the Arnoux view is

arguably the best read of the statute, but it does have the potential to exclude amounts that arguably should not be

excluded (e.g., bonus payments and other kinds of deferred income, along with substantially all retirement account

and pension distributions).

44 See, e.g., In re Scholz, 699 F.3d 1167 (9th Cir. 2012) (in the context of plan confirmation, holding that Railroad

Retirement Act benefits are included in “current monthly income”).

45 Before BAPCPA, many courts would consider social security benefits when evaluating whether a chapter 7 filing

was abusive.

46 See, e.g., In re Cram, 414 B.R. 674, 679-80 (Bankr. D. Id. 2009) (holding in plan confirmation context that 401(k)

distribution was not includable in current monthly income); In re Zahn, 391 B.R. 840, 844-45 (8th Cir. B.A.P. 2008)

(holding same in context of IRA); Simon v. Zittel, 2008 WL 750346 (Bankr. S.D. Ill. Mar. 19, 2008) (same, not

12 K&E 33936875.1

that including retirement account distributions would be unfair to debtors who liquidate their

accounts in an attempt to repay creditors, because such liquidations could inflate the calculation

of income.47 Other courts, by contrast, have reasoned that the purpose of retirement accounts is

to defer income, and the IRC does not treat some forms of retirement contributions as income

until the funds are distributed, and, as a result, distributions should be treated as income.48 This

reasoning is flawed in several ways, though: most retirement contributions are, in fact, subject to

some tax when earned (for example, generally speaking, retirement contributions are not exempt

from payroll taxes); Roth 401(k) and Roth IRA plans are, in fact, taxed in the year of

contribution (though the principal amounts of such plans can be withdrawn tax-free without the

same restrictions as tax-deferred retirement plans); and, most importantly, the definition of

“current monthly income” specifically states that it should be calculated “without regard to

whether such income is taxable income.” This split of authority does not appear to extend to

pensions: at least one court has held that distributions from a contributory pension that was

funded in most significant part by an employer must be included in “current monthly income.”49

Ultimately, the means test is meant to take stock of a debtor’s ability to pay his or her

creditors. There is a good argument that if excluded or exempt assets are going to be included in

the definition of “current monthly income” in the first instance, then both voluntary contributions

to retirement accounts and any penalty-free distributions from retirement accounts should be

included. This approach admittedly has the odd effect of treating the same dollar as “income” at

two different points in time. But the circumstances under which that could matter are narrow

and manageable. As the court noted in Zahn, there may be cases where this approach punishes a

debtor who attempts to liquidate retirement assets to repay creditors, but Zahn and similar cases

do not account for the fact that retirement account distributions may, in fact, be a significant

source of a retiree’s income stream. As a practical matter, however, debtors will not be in the

circumstance of making contributions and receiving distributions simultaneously, and outlier

specifying type of account; In re Wayman, 351 B.R. 808 (Bankr. S.D. Tex. 2006) (holding that funds withdrawn

from an IRA received in a divorce settlement not included in current monthly income). Simon fails to address the

fact that a party generally does not “receive” 401(k) deferrals—they are normally withheld from an employee’s

paycheck—but the better rule for these purposes is to treat the debtor as having been deemed to receive the funds to

deposit into the 401(k), at least where contributions are voluntary.

47 See In re Zahn, 391 B.R. 840, 845-46 (8th Cir. B.A.P. 2008) (also noting that treating a distribution as income

would lead to double-counting because there is no provision in section 101(10A) that allows a debtor not to include

income that is then contributed to the IRA).

48 See, e.g., In re DeThample, 390 B.R. 716 (Bankr. D. Kan. 2008) (holding that distribution from 401(k) included in

“currently monthly income,” but going on to hold that the distribution should not be included in “projected

disposable income” in light of the facts and circumstances); In re Sanchez, 2006 WL 2038616 (Bankr. W.D. Mo.

July 13, 2006) (holding that distribution from 401(k) is included in current monthly income); see also In re

Mendelson, 412 B.R. 75 (Bankr. E.D.N.Y. 2009) (citing DeThample approvingly with respect to its determination

that a one-time withdrawal from a retirement account is not included in “projected disposable income,” but

appearing to approve the determination that the withdrawal would be included in “current monthly income”).

49 See In re Coverstone, 461 B.R. 629 (Bankr. D. Id. 2011) (holding that distributions were included and

distinguishing cases involving distributions from 401(k)s and IRAs); In re Scholz, 699 F.3d 1167 (9th Cir. 2012)

(Railroad Retirement Act benefits are included in “current monthly income”).

13 K&E 33936875.1

cases like those addressed in Zahn could be handled through a judge’s discretion to depart from

the means test where appropriate.

2. Chapter 13 Eligibility: “Regular Income.”

Only individuals with “regular income” may be a debtor under chapter 13.50 “Regular

income” is not a defined term in the Bankruptcy Code, but legislative history and the case law

demonstrates that it is expansive. Specifically, the legislative history provides that “welfare,

social security, fixed pension incomes, [and individuals] who live on investment incomes” meet

the requirement.51 In other words, the cases and legislative history indicate that income from

exempt or excluded sources can serve as “regular income.” This rule is in line with the rule

discussed above that includes most excluded and exempt assets in the definition of “current

monthly income.”

Because social security is explicitly excluded from the definition of “current monthly

income,” there is an argument that social security benefits should not be considered “regular

income” for purposes of chapter 13 notwithstanding the legislative history. At least one court

has recently taken that view.52 A different view is that a debtor’s ability to voluntarily apply

social security benefits to a chapter 13 plan means that social security benefits can satisfy the

“regular income” test.53

Note that there is the potential for significant tension between the definition of “regular

income” as including social security and investment income (presumably including self-funded

retirement accounts) with the majority rule discussed above that holds that distributions from a

retirement account are not included in “current monthly income” when they are distributed. This

tension could lead to situations where a debtor satisfies the “regular income” test by relying on

retirement account distributions, but then has no “current monthly income” because those

distributions are not included. We recommend that the term “income” should be given a

consistent reading to avoid allowing debtors to qualify for chapter 13 based on “regular income”

that cannot be considered “current monthly income” for purposes of the chapter 7 means test or

plan confirmation.

50 11 U.S.C. § 109(e).

51 See, e.g., In re Hammonds, 729 F.2d 1391, 1393-94 (11th Cir. 1984) (citing legislative history and determining

that welfare benefits can constitute “regular income”).

52 See In re Santiago-Monteverde, 512 B.R. 432 (S.D.N.Y. 2014) (concluding debtor whose only source of income

was social security benefits would not be chapter 13 eligible, remanding for determination relating to other possible

income sources).

53 See Collier on Bankruptcy (16th Ed. 2014) ¶ 109.06[a] (“[N]othing in any of these statutes prevents the recipient

of the benefits from being a chapter 13 debtor, and since the definition of an individual with regular income does not

require the ability to have income paid directly to the trustee, they do not pose a barrier to chapter 13 eligibility.”).

14 K&E 33936875.1

B. Chapter 13 Plan Confirmation Issues.

The treatment of excluded or exempt retirement assets comes to a head in the plan

confirmation context. Section 1325(b) of the Bankruptcy Code provides that certain parties may

object to confirmation if a plan does not provide for the payment of all “projected disposable

income” during the applicable plan period. “Projected disposable income” is not a defined term,

but the Supreme Court has held that it means “disposable income” together with any near-certain

changes to disposable income during the plan period.54 “Disposable income,” in turn, is “current

monthly income received by the debtor . . . less amounts reasonably necessary to be expended

[for certain purposes].”55 Amounts necessary to repay loans from retirement plans are expressly

excluded from the calculation.56 Thus, the chapter 13 plan confirmation standard incorporates

the definition of “current monthly income” and the cases interpreting the scope of that provision.

But there are a few notable issues that arise.

First, the exclusion for amounts withheld from an employee by an employer, or provided

by a debtor to an employer, for funding certain tax-benefitted retirement plans in section

541(b)(7)(A) and (B) of the Bankruptcy Code each contain a “hanging paragraph” that provides:

“except that such amount under this subparagraph shall not constitute disposable income, as

defined in section 1325(b)(2).” As an initial matter, the breadth of this exclusion is unclear on a

forward-looking basis—in other words, it is not clear if amounts contributed or withheld for the

listed accounts ever lose the “exclusion.” Additionally, sections 541(b)(7) and 1325(b)(2) are

silent with respect to whether a debtor can continue voluntary contributions on a postpetition

basis. As a textual matter, section 541(b)(7) is drafted in the past tense, addressing amounts

“withheld” or “received” by an employer, rather than amounts to be withheld or to be received.

The definition of “disposable income,” however, speaks to income currently being received.

Courts are deeply divided on whether voluntary retirement account contributions are

permissible in the plan confirmation context. The majority view is that contributions to the kinds

of accounts listed in section 541(b)(7) are not included in “projected disposable income” and can

be made in any amount.57 Other courts have held that no voluntary retirement contributions are

permissible and that section 541(b)(7) only excludes prepetition contributions.58 Still other

54 See Hamilton v. Lanning, 560 U.S. 505 (2010) (holding that “when a bankruptcy court calculates a debtor’s

projected disposable income, the court may account for changes in the debtor’s income or expenses that are known

or virtually certain at the time of confirmation.”).

55 11 U.S.C. § 1325(b)(2).

56 11 U.S.C. § 1322(f). This is a change from pre-BAPCPA law, where many courts held that payments of

retirement plan loans were voluntary and included in projected disposable income, notwithstanding the fact that

failure to pay such loans exposes debtors to penalties.

57 See, e.g., In re Drapeau, 485 B.R. 29, 33-37 (collecting cases, holding that postpetition voluntary contributions

are permitted and not included in projected disposable income, even if contributions were not made prepetition, as

long as the contributions are being made in good faith).

58 See, e.g., In re Jensen, 496 B.R. 615, 621-22 (Bankr. D. Ut. 2013) (addressing split in authority and adopting

continuing contribution approach); In re Noll, 2010 WL 5336916 (Bankr. E.D. Wis. Dec. 21, 2010). The

bankruptcy appellate panel in Seafort also adopted this approach, but the decision was overturned by a more

restrictive view on appeal.

15 K&E 33936875.1

courts attempt to strike a middle ground by holding that a debtor can continue making the same

contributions that a debtor made on a prepetition basis.59

Social security benefits are notable in this analysis (though section 541(b)(7) is not

implicated by social security benefits). Because “disposable income” incorporates the definition

of “current monthly income,” and social security benefits are excluded from “current monthly

income,” it seems obvious that social security benefits are not “disposable income” or “projected

disposable income.” Although the clear majority of courts take that position,60 at least two

courts have held otherwise, though one of them was reversed on appeal.61 The majority view

seems clearly right as a matter of statutory construction, though it seems inconsistent with

allowing social security benefits to constitute “regular income” for purposes of chapter 13

eligibility.

Although the majority view with respect to section 541(b)(7) seems to be the correct

outcome under the statute, and it may serve the societal interest of encouraging retirement

savings, it seems inappropriate to allow a debtor that is in chapter 13 to continue, much less

increase, voluntary retirement savings. For many debtors, utilizing all tax-advantaged retirement

account space would consume all available projected disposable income. On the other hand,

adopting the rule in Jensen essentially imports an “ordinary course transaction” standard by

allowing a debtor to continue his or her prepetition level of savings. Arguably, a prepetition

creditor would have the ability to “screen” for such prepetition contributions by, for example,

only extending credit to an individual with a certain level of post-retirement-contribution income

and including an event of default for increased savings (though, in practice, it seems unlikely that

a consumer creditor would engage in such monitoring).

Second, parties may attempt to argue that even if retirement accounts or assets are

properly not considered “projected disposable income,” a debtor’s plan is not filed in good faith

when it does not contribute some or all of these assets to creditors. Courts have rejected this

argument in the social security context.62 In other contexts, such as the courts following the

59 See, e.g., In re Seafort, 669 F.3d 662 (6th Cir. 2012) (holding that amounts available to debtor after repaying

401(k) loan could not be used to fund voluntary retirement contributions and instead were required to be paid to

creditors).

60 See, e.g., Baud v. Carroll, 634 F.3d 327 (6th Cir. 2011) (holding that social security benefits not “projected

disposable income”); Mort Ranta v. Gorman, 721 F.3d 241 (4th Cir. 2013) (same); Beaulieu v. Ragos, 700 F.3d 220

(5th Cir. 2012) (same).

61 See In re Nicholas, 458 B.R. 516 (Bankr. E.D. Ark. 2011) (concluding that social security benefits are included in

projected disposable income); In re Cranmer, 433 B.R. 391 (Bankr. D. Utah) (same), rev’d Cranmer v. Anderson,

463 B.R. 548 (D. Utah 2011), reversal aff’d In re Cranmer, 697 F.3d 1314 (10th Cir. 2012).

62 See, e.g., In re Welsh, 711 F.3d 1120 (9th Cir. 2013) (courts are foreclosed from considering a debtor’s exclusion

of social security benefits in the good faith analysis, noting that “[w]e cannot conclude, however, that a plan

prepared completely in accordance with the very detailed calculations that Congress set forth is not proposed in

good faith. To hold otherwise would be to allow the bankruptcy court to substitute its judgment of how much and

what kind of income should be dedicated to the payment of unsecured creditors for the judgment of Congress. Such

an approach would not only flout the express language of Congress, but also one of Congress’s purposes in enacting

the BAPCPA, namely to reduce the amount of discretion that bankruptcy courts previously had over the calculation

of an above-median debtor’s income and expenses.”) (internal citations omitted).

16 K&E 33936875.1

majority rule that all voluntary retirement contributions are excluded from projected disposable

income, courts have reserved the right to evaluate the plan under a good faith standard.63

Third, courts have held that a debtor may apply assets that are not “projected disposable

income” to a chapter 13 plan so that the plan is feasible.64

What is the better view here? It seems to us that contributions to a retirement plan should

be included in projected disposable income, to the extent that such contributions are in excess of

contributions that the debtor had historically made. For the sake of consistency, the lookback

period could take some inspiration from the lookback period and caps applied to the exclusion

for contributions to tax-advantaged education savings vehicles under section 541(b)(5) and (6) of

the Bankruptcy Code. On the other hand, if the debtor has a long history of contributions to a

retirement plan and is merely continuing those contributions in the ordinary course, then such

contributions arguably should be encouraged. This issue is discussed further below under

fraudulent transfer considerations.

IV. FRAUDULENT TRANSFER CONSIDERATIONS

As discussed above, the protections afforded to retirement assets are extensive. A key

inquiry therefore becomes whether a debtor’s pre-filing transfer of funds into a retirement

account can be avoided as either a constructive or an actual fraudulent transfer.

As an initial point of reference, a debtor’s transfer of assets into a self-settled spendthrift

trust that would be excluded under section 541(c)(2) of the Bankruptcy Code will generally not

be honored under state law, because state law generally provides that a self-settled trust does not

protect assets from a settlor’s creditors.65 Additionally, state law generally provides that

transfers into any trust, including spendthrift trusts that are not self-settled and asset protection

trusts, are subject to fraudulent transfer law.66

63 See, e.g., In re Vanlandingham, 516 B.R. 628, 637-38 (Bankr. D. Kan. 2014) (“No doubt some debtors might try

to distort their projected disposable income calculation by starting or substantially increasing their retirement

contributions or loan repayments after filing at the expense of their creditors. But [the debtor] is not one of them. . .

. And when an ‘abusive’ case presents itself, the trustee and unsecured creditors are well-armed with the ability to

object to confirmation for lack of good faith under § 1325(a)(3). Indeed, lack of good faith permeates many of the

cases interpreting § 541(b)(7).”).

64 See, e.g., Mort Ranta v. Gorman, 721 F.3d 241, 253-54 (4th Cir. 2013) (holding that nothing in the code requires a

connection between projected disposable income and feasibility); Baud v. Carroll, 634 F.3d 327, 352 n. 19 (6th Cir.

2011) (same); In re Kibbe, 361 B.R. 302, 314 n. 11 (1st Cir. B.A.P. 2007) (same).

65 See RESTATEMENT (THIRD) OF TRUSTS (2003) § 58(2) (“A restraint on the voluntary and involuntary alienation of

a beneficial interest retained by the settlor of a trust is invalid.”). Several states have exceptions to this general rule

for so-called “Alaska trusts,” formally referred to as Domestic Asset Protection Trusts. A full analysis of that issue

is beyond the scope of this report.

66 See A. Hirsch, Fear Not the Asset Protection Trust, 27 Cardozo L. Rev. 2685, 2687-90 (April 2006) (“Under all

existing domestic statutes, fraudulent conveyance law applies to the creation of an asset protection trust.”). Hirsch

does, however, go on to note that certain fraudulent transfer statutes eliminate constructive fraudulent transfer

theories, shorten limitations periods, or impose more stringent burdens of proof with respect to trust transfers; these

nuances are beyond the scope of this report.

17 K&E 33936875.1

The extent to which fraudulent transfer law applies to prebankruptcy planning in the form

of converting non-exempt or non-excluded assets to exempt or excluded assets, however, is

unclear. The legislative history of section 522 provides that “the debtor will be permitted to

convert nonexempt property into exempt property before filing a bankruptcy petition. . . . The

practice is not fraudulent as to creditors, and permits the debtor to make full use of the

exemptions to which he is entitled under the law.”67

Consistent with that legislative history, several courts have held that prebankruptcy

planning generally does not constitute a fraudulent transfer.68 BAPCPA added certain abuse-

curbing provisions that are inapplicable to retirement accounts, but did not otherwise explicitly

modify this principle.69 Indeed, the implementation of the narrow conversion rules in sections

522(o) and 522(p) imply that other conversions should not be subject to challenge. Courts

applying this principle to retirement accounts have held that the conversion of non-exempt assets

into exempt or excluded retirement assets are not fraudulent transfers absent indicia of fraud

beyond the conversion.70 In light of such cases, it seems unlikely that a court would find that

more typical contributions to retirement plans constitute fraudulent transfers. That said, courts

have, in some cases, determined that conversion of exempt assets constituted a fraudulent

transfer.71 And at least one case applied a constructive fraudulent transfer theory where a debtor

engaged in a “fire sale” of non-exempt property to create a homestead exemption.72

The court in Beaudin emphasized the difficulty of determining when a debtor crosses the

line from legitimate pre-bankruptcy planning to a fraudulent transfer, noting that “[i]t is very

difficult for practitioners to know under the tests articulated when to advise a client to take

advantage of pre-bankruptcy planning. . . . The same conduct can be malpractice not to advise in

one jurisdiction, but voidable and grounds for denial of discharge and possibility for disbarment

in another. . . . Unfortunately, this requires the Court to determine when a debtor’s conduct has

67 HR Rep. No. 595, 95th Cong., 1st Sess. 361 (1977).

68 See, e.g., In re Bronk, 444 B.R. 902, 910-20 (Bankr. W.D. Wisc. 2011) (collecting cases and noting that many

courts require that there be some act “extrinsic to” the conversion of nonexempt assets to exempt assets).

69 In re Lacounte, 342 B.R. 809 (Bankr. D. Mont. 2005 (noting that BAPCPA added an express provision limiting

the “conversion by a debtor of nonexempt property into a homestead exemption with the intent to hinder, delay, or

defraud a creditor”).

70 See, e.g., In re Thomas, 2012 WL 2792348 (Bankr. D. Idaho 2012) (conversion of non-exempt insurance policy to

exempt IRA not fraudulent); In re Beaudin, 2010 WL 3748735 (Bankr. D. Colo. Sept. 21, 2010) (IRA opened on the

eve of bankruptcy with funds from non-exempt tax refund not made with actual intent to defraud creditors); In re

Stern, 345 F.3d 1036 (9th Cir. 2003) (pre-BAPCPA, holding that conversion of over $1 million of assets in a non-

exempt IRA into an excludable ERISA-qualified plan was not a fraudulent transfer). Note, however, that Thomas

was principally based on a conclusion that the state law exemption at issue contained no fraud exception.

71 See, e.g., In re Jennings, 332 B.R. 465 (Bankr. M.D. Fla. 2005) (purchase of annuities following large verdict in

anticipation of bankruptcy was fraudulent); In re Levine, 134 F.3d 1046 (11th Cir. 1998) (concluding that debtor

purchased annuities that were exempt under state law with intent to hinder, delay, or defraud creditors).

72 See In re Kemmer, 265 B.R. 224 (Bankr. E.D. Cal. 2001) (concluding that fire sale did not evidence actual fraud,

but holding that the transfers constituted constructive fraudulent transfers).

18 K&E 33936875.1

been so overreaching and egregious as to render that debtor a ‘hog’ rather than a ‘pig.’”73

Unfortunately, the lack of certainty can have dramatic effects: engaging in fraudulent

prebankruptcy planning can result in a denial of an exclusion or an exemption and, at worst, a

denial of the discharge.

This is an area of the law where, it seems, the issues could be resolved with some fairly

simple statutory clarification. For example, why not simply impose an annual limitation on the

amount that a person can contribute to a retirement account in the 12 months before a bankruptcy

filing (such as the annual 401(k) limit of approximately $18,000 currently)? Alternatively, one

could imagine a test that provides something akin to a preference test. That is, any contributions

in the 12 months immediately preceding a bankruptcy filing can be exempt, so long as such

contributions are not 120% or more than the average contribution made by the debtor during the

preceding 3 or 5 years. Indeed, one could even implement bright-line rules along the lines of the

rules that govern the exclusion in section 541(b)(5) and (6) of the Code, which provide that

exclusions and exemptions are not applicable, or are capped, with respect to contributions made

1-2 years before a bankruptcy filing. But to the extent that a debtor has not historically made any

contributions to a retirement account, we wonder what is the policy justification for permitting

that debtor to suddenly create exempt assets by initiating his or her first-ever retirement program

on the eve of bankruptcy?

V. INCONSISTENCIES IN TREATMENT OF HEALTH SAVINGS ACCOUNTS, EDUCATIONAL

SAVINGS ACCOUNTS, AND THE NEWLY-PROPOSED ABLE ACCOUNTS

There is a current legislative proposal74 that may create a new kind of tax-advantaged

savings account targeted toward supplemental savings for designated beneficiaries (generally

family members). These accounts would generally be funded on a post-tax basis and the

distributions would be tax-free to the extent used for a qualified purpose.

Section 541(b)(5) and (6) of the Bankruptcy Code exclude certain tax-advantaged

education savings plans from a debtor’s estate. These exclusions are subject to certain

limitations. Most importantly, amounts contributed within the year before filing are not

excluded, and the exclusions for amounts contributed between one and two years before filing is

capped at $6,225 (an amount that, in light of tuition inflation, is very modest).

Should any exclusion or exemption for the proposed “ABLE” accounts be subject to the

limitations on education savings accounts in section 541(b)(5) and (6) of the Bankruptcy Code,

subject to the much more favorable rules for retirement accounts, or some combination of the

two? On one hand, disability savings are similar, in many ways, to retirement savings—they are

designed to provide for an individual who is not working. Indeed, the proposed ABLE

legislation refers to these accounts as supplementing, rather than supplanting, programs like

social security, and social security benefits are broadly excluded from the bankruptcy process

(with the exception of the chapter 13 issues discussed earlier).

73 Id. at *5.

74 Referred to as the “Achieving a Better Life Experience Act of 2014,” H.R. 647. Please note that the NBC’s

involvement with respect to such accounts’ treatment in bankruptcy is highly confidential.

19 K&E 33936875.1

On the other hand, not all health-related accounts contain explicit exclusions or

exemptions. For instance, as noted earlier, health savings accounts, which are triple

tax-advantaged accounts that are intended to be used to defray unreimbursed medical expenses,

are not explicitly covered by any federal exclusion or exemption. Certain state-law exemptions

apply to such accounts, and the dust has not completely settled on whether any federal exclusions

or exemptions apply (though some courts have concluded that the exclusion in section 541(b)(7)

for state-regulated health insurance plans does not apply). Thus, health savings accounts are

generally left to the same questions that plagued IRAs before BAPCPA was enacted.

We believe that the best answer would be one that calls for consistency. All of these

types of accounts serve similar purposes, and all of them contain limitations that restrict the

amounts that can be contributed to them (e.g., the annual contribution to a health savings account

cannot exceed the amount of the individual’s health-care deductible). Unlike IRAs and ERISA

accounts that can sometimes rise into the millions, it is hard for an educational savings account

or a health savings account to rise to that level (given the significant restraints on annual

contributions). As a result, we would favor a proposal that would treat all such accounts

similarly under the Bankruptcy Code, i.e., with such assets entitled to exclusion under Section

541 with appropriate caps and limits on when such contributions can be made shortly before a

bankruptcy filing.

VI. CONCLUSION

The exclusions and exemptions provided to retirement assets in the Bankruptcy Code are

especially broad, particularly after BAPCPA. In some ways, that protection might be considered

too generous: with the exception of the pre-BAPCPA exemption for retirement accounts in

section 522(d)(10)(E), which has been rendered largely superfluous by the much broader

exclusions and exemptions elsewhere in the Code, the exclusions and exemptions generally are

not limited to reasonable retirement needs as measured by an objective standard. Of course, the

end result of this is to provide greater protections for people with higher incomes that can take

advantage of these generous exclusions and exemptions. That is sharply in contrast to the overall

means testing regime implemented as a gatekeeper to perceived abuses of the chapter 7 process

and the general principle that exemptions and exclusions are intended to keep a debtor from

becoming a public charge without providing a “windfall” vis-à-vis creditors who are not being

paid in full. Moreover, there are significant inconsistencies between the treatment of retirement

assets under different circumstances and for the purposes of different tests. And, even once the

statutory inconsistencies are understood, there are numerous splits in the case law.

Ultimately, the goal of individual chapter 7 and chapter 13 is to balance a debtor’s fresh

start against creditor recoveries. That goal is not served by the inconsistent rules now applicable

to retirement funds in the different contexts explored in this report. While a proposal for

comprehensive reform is beyond the scope of this report, certain obvious steps could be taken to

harmonize current inconsistencies, such as establishing an applicable cap for all retirement asset

exclusions and exemptions and setting consistent, clear rules for the treatment of distributions

and voluntary postpetition retirement contributions in the chapter 13 context, and the potential to

implement consistent look-back/clawback periods and caps for contributions made within 1-2

years of a bankruptcy filing.