Annuity Purchased with Tax-Exempt Rollover Funds Exempt in Bankruptcy

Posted by NCBRC - November 18, 2013

The BAP for the Eighth Circuit found that, under section 522(b)(3)(C), the debtor could exempt an Annuity purchased with funds rolled over from a tax-exempt IRA. In re Miller, No. 13-6026 (Nov. 4, 2013).

The Annuity consisted of a Contract dictating terms of payments to the debtor, an Endorsement specifying that the Annuity must be paid for no later than the Contract Issue Date and no payments may be made thereafter, and an IRA Agreement specifying that its terms control in the event of a conflict with the Contract and that the Annuity is expected to be treated as an Individual Retirement Account within the meaning of ERISA and section 408(b). The parties agreed that because the purchase price exceeded the IRC annual limits, had the Annuity been purchased other than by funds from a rolled over tax-exempt IRA, it would not be exempt under section 408 of the Tax Code and, therefore, would not have been exempt in bankruptcy. The bankruptcy court found that, because the Debtor purchased the Annuity through a direct rollover from another tax-exempt IRA, the funds retained their tax-exempt status after the rollover.

The BAP agreed. It found that the Annuity documents themselves evidenced an intent to comply with section 408(b). In addition to referencing section 408(d)(3) which contemplates Annuities purchased through IRA rollovers, the IRA Agreement indicated that the Annuity should be treated “as a Traditional Individual Retirement Annuity under the Employee Retirement Income Security Act of 1974 [(‘ERISA’)].”

The trustee objected to the exemption on the basis that it did not conform to the requirements of section 408(b) which provide that tax exempt status is contingent upon the following requirements:

(2) Under the contract—

(A) the premiums are not fixed,

(B) the annual premium on behalf of any individual will not exceed the dollar amount in effect under section 219(b)(1)(A) [currently capped at $5,500]

The trustee argued that since the Annuity was purchased in a single, fixed payment, it did not comply with these sections.

The court found that 408(b)(2)(B) does not require that premiums be paid into the account, but rather, dictates that if premiums are paid they must not exceed the limit set forth in section 219(b)(1)(A). This requirement prevents the annuitant from shielding his income by placing all of it in the annuity. Because the fund was purchased with a rollover contribution under section 408(d), the limit in effect under section 219(b)(1)(A) was not applicable.

The trustee’s reliance on section 408(b)(2)(A) were equally unavailing. The court found that, in this case, the premiums (to the extent that the purchase price could be deemed a premium) were not “fixed” within the meaning of section 408(b)(2)(A) because the debtor simply elected to rollover an amount he chose. The requirement with respect to flexible premiums is intended to protect an annuitant from having to pay a fixed amount even if his income goes down.

The court concluded that the annuity purchased with funds rolled over from a tax-exempt IRA retained its exempt status under section 408 of the IRC and, therefore, could be exempted in bankruptcy.

Miller opinion



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