Asset Protection and Bankruptcy

The new bankruptcy law changes some of the rules regarding the asset bankruptcy protection: Qualified retirement plans and Individual Retirement Account (IRAs). As under prior law, assets in qualified plans are fully protected from the claims of creditors. The new law has clarified that this protection extends to IRA rollovers that are funded with distributions from qualified retirement plans. However, the new asset bankruptcy protection law limits protection for funds in IRAs. The maximum amount of exempted funds is $1 million. This limit will be adjusted for inflation in the future.

(Note: Although the U.S. Supreme Court had previously ruled that funds in an IRA were exempt (Rousey v. J.R. Jacoway,SCt, 2005-1 USTC A�50,258); it did not place any cap on this exemption or give recognition to the asset bankruptcy protection law that had been pending at the time.)

Residences

The states of Florida and Texas had provided unlimited homestead protection for personal residences, while other states had more modest protection for homes. The new bankruptcy law provides uniform treatment overriding the different state rules. The exemption is now capped at $125,000 if the home was acquired within 3.3 years (1,215 days) of filing for asset bankruptcy protection. Therefore, homes owned prior to this time continue to enjoy unlimited protection in Florida and Texas..

Education savings plans. The new asset bankruptcy protection law created for the first time clear protection for funds in 529 plans. For anyone unfamiliar with asset bankruptcy protection, a 529 plan is a state-operated investment plan giving families a federal tax-free way to save money for college. It was authorized by Congress in 1996. These plans are officially known as qualified tuition programs (QTPs), but more commonly referred to as "529 plans," "state 529 plans" or "section 529 plans" after the section of the IRS code providing the plans' special tax breaks.

Coverdell education savings accounts are protected as well (A Coverdell education savings account (ESA) is a savings account, created under the aegis of the IRS, as an incentive to help parents and students save for education expenses). Contributions made within a year of filing for bankruptcy are not protected. Contributions made between one and two years of filing are protected only up to $5,000. Older contributions are fully protected.

SECTION 541 of the Bankruptcy Code

(6) funds used to purchase a tuition credit or certificate or contributed to an account in accordance with section 529(b)(1)(A) of the Internal Revenue Code of 1986 under a qualified State tuition program (as defined in section 529(b)(1) of such Code) not later than 365 days before the date of the filing of the petition in a case under this title, but—

(A) only if the designated beneficiary of the amounts paid or contributed to such tuition program was a child, stepchild, grandchild, or stepgrandchild of the debtor for the taxable year for which funds were paid or contributed;

(B) with respect to the aggregate amount paid or contributed to such program having the same designated beneficiary, only so much of such amount as does not exceed the total contributions permitted under section 529(b)(7) of such Code with respect to such beneficiary, as adjusted beginning on the date of the filing of the petition in a case under this title by the annual increase or decrease (rounded to the nearest tenth of 1 percent) in the education expenditure category of the Consumer Price Index prepared by the Department of Labor; and

(C) in the case of funds paid or contributed to such program having the same designated beneficiary not earlier than 720 days nor later than 365 days before such date, only so much of such funds as does not exceed $5,000.

Asset protection trusts. Currently twelve states, including, Alaska, Delaware, Nevada, Rhode Island and Utah, allow individuals to create self-settled trusts to protect their assets. The grantor can be both a beneficiary and trustee of these trusts while blocking creditors from any assets held in the trusts. The new asset bankruptcy protection law limits the protection to transfers of property made within 10 years of filing for bankruptcy only if the transfers were not made with the intention to hinder, delay or defraud creditors, so protection can be obtained.

It should be noted that these states permit nonresidents to set up asset protection trusts within their borders, provided that there is a resident trustee. However, it has not yet been tested whether nonresidents can enjoy the same asset protection as residents, and the bankruptcy law does not clarify this point.