Are Individual Retirement Accounts (IRA’s) Protected When You File Bankruptcy?

Most of the time an IRA or Roth-IRA is protected or exempt by both Federal and State Exemption Laws.   The Tennessee exemption law is found at T.C.A. §26-2-105 and provides that as long as the retirement plan is qualified by the Internal Revenue Code the funds are exempt from any and all claims of creditors, except the state of Tennessee.   The Federal exemption which is found at 11 U.S.C. § 522(b)(3)(C), exempts retirement funds to the extent that those funds are in an account that is tax exempt under 408 of the Internal Revenue Code.

The Bankruptcy Court in the Eastern District of Tennessee at Knoxville found that if a prohibited transaction was done, even inadvertently, by the contributor to the  retirement account, the funds in the IRA are no longer a valid IRA under the Internal Revenue Code and therefore are not exempt from creditors. See In re Dailey, 459 B.R. 270 (Bankr. E.D. Tenn. 2011)

In the Dailey case, the debtor opened a Merrill Lynch IRA and as part of the documentation he was given to review and sign, Mr. Dailey signed a Merrill Lynch Client Relationship Agreement.  The Merrill Lynch Client Relationship Agreement had as standard language in the agreement that “Merrill Lynch has a lien on accounts and amounts in those accounts for any payment obligation with Merrill Lynch”.   Although the Bankruptcy Judge found that the debtor never borrowed from his IRA account or requested a loan against the funds, the debtor agreed to the Terms and Conditions of the Client Relationship Agreement that included allowing Merrill Lynch to have a lien on his IRA account.   Both the debtor and the Trustee stipulated  or agreed in the Daily case that the debtor was “not materially responsible” for the Merrill Lynch IRA not being in compliance with the Internal Revenue Code, or in other words, the debtor did not intentionally give Merrill Lynch the lien.  However, the Bankruptcy Judge found that the IRA was still not exempt or protected from his creditors because the debtor signed this agreement when he opened the account resulting in Merrill Lynch having a lien against the funds in the IRA.    The Dailey case is on appeal to the Sixth Circuit Court of Appeals.

It is very important to seek the advice of an experienced bankruptcy attorney like the attorneys at Bond and Botes to make sure your retirement account is exempt or protected prior to filing a bankruptcy.