I have a friend, a fellow bankruptcy attorney, who decries the excessive use of hyphens, so he might get a little upset by the title of today’s post.  However, the hyphenation is perfectly correct here.  Now to the post.

I recently received an email from a fellow bankruptcy attorney — not the one who is concerned about hyphens — that asked whether tax-deferred retirement accounts that are not ERISA-qualified are in jeopardy in a Chapter 7 bankruptcy.

I.          The California Exemption Tables

As a preface to answering the question posed, let me remind you of the concept of exemption, about which I have written many times.  For example, I wrote:

In a Chapter 7 bankruptcy, the Chapter 7 Trustee assigned to the case is empowered to seize bankruptcy estate assets and liquidate them for the benefit of creditors.  However, any of the debtor’s assets that are excluded from the estate under 11 U.S.C. § 541(b) are protected from the Chapter 7 Trustee’s depredations.  . . .  [A]ny estate assets that the debtor can exempt are also protected from the clutches of the Chapter 7 Trustee.  The Bankruptcy Code has an exemption table which is found in 11 U.S.C. § 522.  However, the Bankruptcy Code — which is federal law — permits the states to use their own exemption tables.  California is unique among the states in that it has chosen to have two exemption tables for bankruptcy:  one for homeowners with equity, found in Cal. Civ. Proc. Code § 704, and the other for everyone else, found in Cal. Civ. Proc. Code  § 703.140.

Without knowing what kind of tax-deferred accounts a particular debtor has, it is difficult to make a blanket statement.  With that caveat I offer the following thoughts and strategies as general information.  Call me if you have more specific details on a particular account.

II.        Argue That The Accounts Are “ERISA-Like”

On a first pass begin by considering the holding in Rousey v. Jacoway, 544 U.S. 320 (2005).  In that case the Supreme Court considered the exemption of non-ERISA qualified IRAs and held:

The Bankruptcy Code permits debtors to exempt certain property from the bankruptcy estate, allowing them to retain those assets rather than divide them among their creditors.  11 U.S.C. § 522.  The question in this case is whether debtors can exempt assets in their Individual Retirement Accounts (IRAs) from the bankruptcy estate pursuant to § 522(d)(10)(E).  We hold that IRAs can be so exempted.

Rousey at 322.

The Court held that four key characteristics of IRAs made them sufficiently like ERISA-qualified plans that they could be exempted as if they were ERISA-qualified:

Several considerations convince us that the income the Rouseys will derive from their IRAs is likewise income that substitutes for wages.  First, the minimum distribution requirements, as discussed above, require distribution to begin at the latest in the calendar year after the year in which the accountholder turns 70½.  Thus, accountholders must begin to withdraw funds when they are likely to be retired and lack wage income. Second, the Internal Revenue Code defers taxation of money held in accounts qualifying as IRAs under 26 U. S. C. § 408(a) (2000 ed. and Supp. II) until the year in which it is distributed, treating it as income only in such years. §§ 219, 408(e) (2000 ed. and Supp. II).  This tax treatment further encourages accountholders to wait until retirement to withdraw the funds:  The later withdrawal occurs, the longer the taxes on the amounts are deferred.  Third, absent the applicability of other exceptions discussed above, withdrawals before age 59½ are subject to a tax penalty, restricting preretirement access to the funds.  Finally, to ensure that the beneficiary uses the IRA in his retirement years, an accountholder’s failure to take the requisite minimum distributions results in a 50-percent tax penalty on funds improperly remaining in the account. § 4974(a).  All of these features show that IRA income substitutes for wages lost upon retirement and distinguish IRAs from typical savings accounts.

Id. at 331-32.

The Court concluded that IRAs were similar enough in nature to ERISA-qualified plans to be exempted because “they confer a right to receive payment on account of age and they are similar plans or contracts to those enumerated in § 522(d)(10)(E).”  Id. at 334-35.

Therefore, depending on the nature of the accounts, a debtor (i.e., the debtor’s counsel) may appeal to Rousey’s reasoning to argue by analogy that the accounts are ERISA-like and then appeal to Rousey’s holding to exempt them.

III.       Review Cal. Code Civ. Proc. § 704.115

A careful reading of Cal. Code Civ. Proc. § 704.115  may also provide a way to protect the accounts.  That section is fairly broad in scope — a bit broader than the corresponding one in Cal. Code Civ. Proc. § 703.140(b)(10)(E) — so the accounts may fit within its ambit.

The exemption maven might complain that since Cal. Code Civ. Proc. § 704 is the homeowners with equity table, it is inapplicable to a debtor without equity.

However, a debtor can use that section even if that debtor has no home equity.  In fact, a renter can use that table.  Renters usually use the Cal. Civ. Proc. Code  § 703.140 table because it has the wildcard exemption of § 703.140(b)(5), which can be used on any asset that can’t be exempted using one of the other exemption categories in that table.  Thus, using the homeowners table means the loss of the wildcard.  Therefore, a careful weighing of the benefits of using the § 704 table against the loss of the wildcard must be done before making the choice.

IV.       Exclude The Accounts From The Estate Under 11 U.S.C. § 541(b)

11 U.S.C. § 541(a) lists the contents of the bankruptcy estate, and then § 541(b) removes certain assets from the estate.  Therefore, if the accounts are in a 457 plan (457 plans are not ERISA qualified; see the IRS paper, another approach to consider is appealing to 11 U.S.C. § 541(b)(7)(A)(II) and (B)(II).  Such accounts are excluded from the estate altogether without the need to apply an exemption.  Take a look at the account statements to determine their nature to see if this argument can work.

V.       The Reasonable And Necessary Standard

Finally, as for the “reasonable and necessary” standard stated in Cal. Code Civ. Proc. § 703.140(b)(10)(E) (“. . . to the extent reasonably necessary for the support of the debtor and any dependent of the debtor . . .”) there really isn’t a clearly defined one.  Much will depend on your judge.  Therefore, your analysis will have to focus on the peculiar needs of the debtor and the debtor’s dependents.

For example, if the debtor is over sixty-five and has a serious medical condition that requires round the clock care, “reasonable and necessary” will be considerably more than if the debtor is thirty, single, and in good health.  A nice summary of a few cases in which Courts have considered what is meant by reasonable and necessary living expenses within the context of a Chapter 13 bankruptcy is found in In re Stout.  Although it doesn’t address the amount in a retirement fund that is reasonable and necessary, it gives relevant factors to be used in making the determination.  These factors should then be applied in an actuarially predictive sense to the likely future needs of the debtor to answer the question:  How much does the debtor need in retirement to cover these future expenses?

Here is the relevant bit of the Stout Court’s discussion.  It’s a little long, but worth the read:

The Bankruptcy Code requires a meaningful and realistic budget, accompanied by the devotion of most of the debtor’s surplus income to repay creditors.  In re Downin, 284 B.R. 909, 912 (Bankr. N.D. Iowa 2002).  Chapter 13 debtors are not required to live as paupers; neither are they allowed to continue an extravagant lifestyle at the expense of creditors. Butler, 277 B.R. at 920. Courts apply § 1325(b) to allow debtors to maintain a reasonable lifestyle while simultaneously insuring they make a serious effort to pay creditors by eliminating unnecessary and unreasonable expenses. In re Wessels, 311 B.R. 851, 855 (Bankr. N.D. Iowa 2004).  Some expenditures are clearly essential, or nondiscretionary, such as reasonable amounts budgeted for food, clothing and shelter.  Debtors are also allowed some latitude regarding discretionary spending for items such as recreation, clubs, entertainment, newspapers, charitable contributions and other expenses.  The proper methodology is to aggregate all expenses projected by the debtor which are somewhat more discretionary in nature, and any excessive amounts in the relatively nondiscretionary line items such as food, utilities, housing, and health expenses, to quantify a sum which, for lack of a better term, will be called “discretionary spending.”  Downin, 284 B.R. at 912-13 (citations omitted).  Discretionary expenses identified by courts include charitable contributions, gifts, recreation, private school tuition, payments for boats, campers and other luxuries, health club and country club dues, and newspapers and magazines.  Butler, 277 B.R. at 921.  Courts also scrutinize cable TV services, veterinary expenses, cell phones, unspecified home repairs, and deductions for voluntary retirement funds. See 2 Keith M. Lundin, Chapter 13 Bankruptcy §165.1 (3d ed. 2000); In re Attanasio, 218 B.R. 180, 201-10 (Bankr. N.D. Ala.1998) (extensively collecting cases considering excessive or unreasonable expenses in the context of § 707(b) substantial abuse determination).  In In re Rathbun, 309 B.R. 901, 907 (Bankr. N.D. Tex. 2004), the court stated that more than parental preference is required to sustain an expenditure of $900 per month for private school tuition.  The court upheld a finding that annual educational expense for four children of $53,640 was “excessive and possibly even extravagant” in In re Kornfield, 164 F.3d 778, 784 (2d Cir. 1999).  Expenses for golf and music lessons were found not reasonably necessary in In re Falke, 284 B.R. 133, 139 (Bankr. D. Or. 2002).  Substantial abuse was found in In re Walsh, 287 B.R. 154, 157 (Bankr. E.D.N.C. 2002), where the debtors were paying expenses for private schools, hockey, travel and country club dues.  The court noted that the debtors were “motivated by a sincere desire to provide for their children the education and developmental activities that they consider best.”  Id.  Telephone, cell phone, cable TV and internet expenses were scrutinized in In re Oimoen, 325 B.R. 809, 811 (Bankr. N.D. Iowa 2005), and Downin, 284 B.R. at 913.

In sum, the debtor isn’t expected to have just one hot meal a day:  a bowl of steam (with apologies to Woody Allen in Take The Money And Run).

On the other hand, a strict diet of fine French food, king crab and prime rib, and fine Bordeaux wines each night will not pass the dietary muster.  Indeed, doctors will undoubtedly tell you that such a rich diet isn’t good for you, although if I had enough money to do so, it’s a risk I’d be willing to take.

If you have some non-ERISA, tax deferred retirement accounts and want to protect them in bankruptcy, don’t go it alone because you might lose them.  Instead, hire a high-quality, California State Bar board-certified bankruptcy attorney specialist to help you.