On April 20th, the President signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“Act”). The Act makes significant changes in the bankruptcy rules, including adding specific protections for retirement plans. The Act goes into effect for bankruptcy petitions filed after October 16, 2005.

Retirement Plans. The new law exempts from the bankruptcy estate assets held by a qualified plan, 403(b) plan, 457 plan or IRA (traditional, Roth, SEP and SIMPLE). The effect of the exemption is to place retirement plan assets beyond the reach of creditors during or after the bankruptcy proceeding. The exemption for retirement plan assets applies irrespective of whether the debtor elects the federal or state bankruptcy exemptions. However, the new law contains an exception for federal tax liens.

IRA Limitation. The new law limits the application of the exemption for IRAs to $1,000,000. However, the $1,000,000 limitation does not apply to rollovers or to employer contributions (e.g., SEP or SIMPLE). Since regular contributions to IRAs are substantially limited, the $1,000,000 cap likely will not have any impact for many years. Nevertheless, debtors with large rollovers or significant employer contributions will need to establish and maintain records of the contributions to distinguish between regular IRA contributions, rollovers and employer contributions. This new limitation may require individuals to reconstruct prior contributions and rollovers. An IRA participant also may want to maintain a separate IRA for rollovers to identify which amounts are subject to the limitation and which amounts are not. The new law imposes no dollar limitation on the exemption for other retirement plans.

Rollovers. Amounts directly rolled over to another retirement plan or IRA qualify for the exemption as do amounts distributed and rolled over within the 60-day rollover period.

Determination Letter. In order for a debtor to qualify for the exemption, the retirement plan benefits must be held in a plan that satisfies the applicable requirements under the Code. The Act will presume that a retirement plan is qualified if it has received a favorable determination letter. Unfortunately, the Act is not clear as to whether a plan that relies on the prototype or volume submitter opinion letter as its “determination letter” will qualify for the same presumption. Until this issue is clarified, an employer maintaining its plan on one of these pre-approved forms and that wants to be certain that the protection applies, should obtain a determination letter.

A debtor in a plan that does not have a determination letter will need to demonstrate that (1) neither the IRS nor a court has made a determination that the plan is not qualified, and (2)(a) the plan is in substantial compliance with the Code, or (b) the plan is not in substantial compliance but the debtor is not materially responsible for that failure.

Prior Court Decisions. For more than a decade, courts have relied on the Supreme Court decision in Patterson v. Shumate to exclude “ERISA qualified plan” assets from the bankruptcy estate. However, many courts concluded that the Patterson decision did not afford protection for non-ERISA plans (e.g., owner-only plans, IRAs, governmental plans). The new law does not change the Patterson decision, but it does broaden the protection to apply to plans not subject to ERISA.

Recently, the Supreme Court in Rousey v. Jacoway ruled that the exemption for retirement plans also included IRAs. However, the decision limited the exemption to amounts reasonably necessary for the support of the debtor. Furthermore, the debtor only may avail himself/herself of the exemption if the debtor forgoes the potentially more valuable state exemptions in favor of the federal exemption.

Participant Loans. The new law makes it clear that bankruptcy does not discharge a participant loan. Furthermore, bankruptcy will not affect the participant’s ability to repay the loan through payroll deduction. In previous decisions, the courts generally terminated payroll deduction agreements to repay loan thereby causing a taxable deemed distribution.

Plan Administrator. Where the debtor is acting as plan administrator, the new law requires the bankruptcy trustee to assume any duties the debtor had as plan administrator. If there is no bankruptcy trustee, the debtor will continue to act as the plan administrator.