Annuities and Bankruptcy Filing Include IRA Protection

A bankruptcy filing allowed a doctor who was sued to protect his IRAs from the litigants because undistributed IRAs need not be counted by a debtor as "disposable income," a divided Fourth Circuit held. (Re Solomon (1995, CA4) 1995 US App LEXIS 29795).

Neil Solomon, M.D., filed a Chapter 13 bankruptcy petition. His creditors were three former patients (and the spouse of one) who sued him in tort for alleged misconduct during their treatment as his medical patients. Their claimed compensatory and punitive damages totaled $160 million. In his bankruptcy plan, Solomon scheduled assets valued at $2.18 million of which he claimed $2.14 million to be exempt from the claims of his creditors. Of the assets claimed as exempt, $1.4 million was held in three individual retirement accounts (IRAs).

Reg § 1.408-2(b)(6), which permits withdrawals at age 59½, does not require that income be withdrawn from IRA accounts until a recipient reaches age 70½. Solomon, who is 62 years old, told the bankruptcy court that he had no intention of withdrawing any funds from the IRAs during the term of the bankruptcy plan. Moreover, under Maryland law, IRAs are exempt from execution by creditors. (Md. Cts. & Jud. Proc. Code Ann. Section 11-504(h)).

After his petition was filed, Solomon voluntarily surrendered his medical license and ceased practicing medicine. As a result, his net monthly income decreased from $14,800 to $2,650 (which consisted primarily of monthly mandatory distributions from his Maryland State Pension). According to the plan, Solomon proposed to pay the bankruptcy trustee $750 per month for an extended term of five years, for a total payout to creditors of $45,000. He planned to use the remainder of his monthly income, together with the income from investments and exempt assets other than his IRAs, to pay his normal living expenses.

Under 11 USC 1325(b), disposable income is income which is received by the debtor and which is not reasonably necessary to be spent on his (or any dependent's) maintenance or support. If (as here) the trustee or the holder of an allowed unsecured claim objects to the confirmation of a Chapter 13 plan and the plan proposes less than full payment of unsecured claims, the plan may be confirmed only if it provides for payments of "all of the debtor's projected disposable income" to be received during the life of the plan.

The Fourth Circuit said that Solomon's IRAs were not "income" under the clear terms of 11 USA 1325(b). Both the statutory definition of "disposable income" as income that is received by the debtor, as well as the statute's requirement that projected income be calculated over the life of the plan, pertain to income that a debtor is actually receiving at the time of the confirmation, the court reasoned.

Projected disposable income typically is calculated by multiplying a debtor's monthly income at the time of confirmation by 36 months, the normal duration of a Chapter 13 plan, then determining the portion of that income which is "disposable" according to the statutory definition. It was undisputed that, at the time of the confirmation hearing on Solomon's bankruptcy plan, he was not actually receiving any disbursements from his IRAs. And he further insisted that he had no intention of withdrawing funds from the IRAs during the life of the plan.

On these facts, the Fourth Circuit said that it could not sanction the bankruptcy court's inclusion of a hypothetical amount of income from the IRAs– based on the periodic distributions he could receive without penalty under Reg § 1.408-1(b)(6) which permits withdrawals at age 59½ – in the calculation of Solomon's disposable income. Rather than engaging in "hopeless speculation about the future," a court should determine projected disposable income by calculating a debtor's present monthly income and expenditures and extending those amounts over the life of the plan, the court said. Solomon's present, regular monthly income does not include distributions from his IRAs, and the bankruptcy court's imputation of amounts from such speculative distributions in its calculation of disposable income was contrary to the plain terms of the statutory definition, the court Fourth Circuit determined.

Thus the Fourth Circuit found that Chapter 13 debtors are not required to withdraw pension or retirement income to fund a bankruptcy plan that otherwise meets the rules under 11 USC 1325. "A contrary holding could have devastating results for pension and retirement savings," the Fourth Circuit reasoned.

Dissent. The dissent focused on the fact that Solomon, who has retired, refuses to make available to his creditors any income (which is readily accessible without penalty) from three exempt IRAs worth more than $1.4 million. The dissent noted that the retired doctor does not need any income from the IRAs for the reasonable maintenance and support of himself or any dependent. Thus the dissent would have counted the income that Solomon could elect to receive without penalty from his IRAs as projected disposable income for purposes of his Chapter 13 plan. The dissent favored the bankruptcy court's suggestion that a minimum annual IRA distribution be dedicated to the payment of Solomon's creditors during the life of his plan. Thereafter, Solomon (or any other Chapter 13 debtor) would get all of his IRA distributions for the rest of his (projected) lifetime.

Reprinted with permission of Pension and Benefits Week, November 13, 1995. Research Institute of America. Subscriptions: 800-421-9025, $250/ yr.