Most people assume that if something goes really wrong in their financial life, at least their retirement accounts are protected from creditors. These same people generally assume that if their Traditional IRA is protected, their Roth IRA is also protected. They also believe that if they are ever forced into bankruptcy, their Traditional IRAs and Roth IRAs will survive the bankruptcy to provide them with enough to live on afterward. But as we will see below, such assumptions can be quite dangerous.
The debtor, Hoffman, filed for Chapter 7 bankruptcy in the U.S. Bankruptcy Court for the Northern District of Georgia. In his schedules, Hoffman’s exempt assets included a Roth Conversion IRA and a Roth Contributory IRA. Hoffman’s primary creditor, Signature Bank of Georgia, opposed Hoffman’s exemption request for the two Roth IRAs on the grounds that the Roth IRAs were not exempt under the Bankruptcy Code or Georgia law. applies. The bankruptcy court ruled in favor of Signature Bank, but noted that Georgia’s garnishment law had recently been revised and the US District Court agreed to deny the exemption. Hoffman then appealed to the United States Court of Appeals for the Eleventh Circuit, asserting that both Roth IRAs should be excluded from his bankruptcy estate, and the Eleventh Circuit then issued the opinion which I will relate next.
The Eleventh Circuit noted that among the elements to prove whether a Roth IRA is excluded from the debtor’s bankruptcy estate is whether the Roth IRA has a transfer restriction that is enforceable under federal or state law. ‘State. In this regard, Georgian law provides that “[f]Funds or benefits from an Individual Retirement Account or a pension or retirement program are exempt from garnishment until they are paid or otherwise distributed to a member of such program or its beneficiary. Â»
The problem is that an earlier decision had established that under prior Georgia law a Roth IRA had to be included, not excluded, from the debtor’s bankruptcy estate (and therefore available to creditors) because the Georgia had not extended traditional IRA protections to Roth. IRA.
Georgia law was amended in 2016, however, to eliminate any difference in protections for traditional IRAs and Roth IRAs. Thus, the Eleventh Circuit concluded that Roth IRAs held by a Georgia debtor were to be excluded from the debtor’s bankruptcy estate and therefore were not available to creditors.
The Eleventh Circuit’s reasoning in this case is very simple, and the result should come as no surprise. The reason I mention this case is that it highlights a very important fact: whether Roth IRAs are protected from creditors is largely a state-by-state matter, depending on the laws of the creditors’ exemption from the state where the debtor resides at the time the bankruptcy petition is filed.
Trying to determine whether a particular state protects Roth IRAs is sometimes easy, such as when a state simply lists Roth IRAs as excluded assets, but sometimes it’s not that easy and you may have a first impression case within this state. Note that there may also be differences from state to state between Roth IRAs that are funded by contributions and those that are funded by rollovers.
For planners, this type of state-by-state analysis also presents challenges because clients tend to move around. Although the customer’s Roth IRA may be protected in the state it is in, the customer can then choose to move to a state where the Roth IRA is unprotected or protected only under a “means test” requiring a additional assessment that the Roth IRA is required to fund its basic needs in retirement â¸º and often at a near-minimal standard of living.
The point being that a planner cannot simply determine that a client’s Roth IRA is protected as of today, but must notify the client that if they change their state of residence, they will again have to go through an analysis to find out if the Roth IRA is protected in the new state as well (clients will just assume that it will be).
The most important point, of course, and as this opinion emphasizes, is that planners should also not assume that just because traditional IRAs are protected in a given state, Roth IRAs are also protected.
Finally, I would like to point out that most state laws are hardwired so that the protection of all IRAs, traditional and Roth, depends on whether the IRA is deemed such under the US tax code. So, if a client violates a provision of the tax law such that the IRA cannot be considered as such from a tax perspective, the creditor’s exemption also disappears immediately. Anecdotally, this seems to happen quite often with debtors in financial difficulty who start doing things they shouldn’t with their IRAs when they find themselves underwater, only to find that what they thought being their last exempt asset is not exempt at all.
Be careful, because Roth IRA protections aren’t uniform or sometimes easy to understand, and they can easily be lost.
In re Hoffman (Hoffmann v. Signature Bank), 11th Cir. No. 20-12823 (January 24, 2022).
Hats off to Chris Riser for sharing this opinion with me.