Wash Away Debt in Bankruptcy and Keep Your IRA? Yes, You Can Do It.

Financial planning isn’t always about champagne dreams and caviar wishes. For many, it is simply about not drowning in debts after retirement.

I recently met with a client to discuss her options dealing with significant credit card debt. She is nearing retirement and did not know how she could make ends meet on a fixed income. She was hesitant to file bankruptcy because she was afraid she would lose her IRA to creditors if she did.

Like my client, many people avoid bankruptcy because they fear losing their IRA in the process. But it is almost always a bad idea to tap IRA money to pay debts. The IRS will assess a 10%penalty and income taxes on the withdrawn money if you are not yet age 59 ½. Also, you may find yourself running short of funds later in retirement when you will likely need the money.

Michigan and federal bankruptcy law offer IRA protection from creditors in bankruptcy. A bankruptcy filer in Michigan may use either state or federal exemptions to protect an IRA while getting rid of debts.

Under Michigan law, you may protect all traditional and Roth IRAs accounts in bankruptcy, including payments or distributions from those accounts or annuities. The Michigan exemption does not extend to money contributed to the IRA made within 120 days before filing bankruptcy. Second, the exemption does not protect IRAs from an order of a domestic relations court (spousal or child support). Finally, the exemption does not protect nondeductible contributions to an IRA or annuity contract.

The United States Bankruptcy Code protects traditional and Roth IRAs accounts to a combined limit of $1,362,800 (inflation adjusted). You can have any number of accounts of any type as long as the combined total of all such accounts does not exceed the exemption limit.

If the IRA consists of funds rolled over from an employer sponsored account, such as a 401(k) or 403(b), the dollar limit does not apply. The rollover funds will retain the unlimited protection under federal law.

The federal IRA exemption would work better for my client. Her IRA isn’t that large, and the federal exemptions for her other assets are more attractive than the Michigan exemptions.

You must consider many factors in making a decision to file bankruptcy. If you are at the point where you are considering an IRA withdrawal to pay down debts, bankruptcy may be the better option.

If you are struggling with debt and looking for a solution, give us a call, I can help you.

Debtor has Student Loan Debt of $221,000 Discharged in Bankruptcy.

Navy veteran, Kevin Rosenberg, borrowed $116,000 in student loans from 1993 to 2004 to earn a bachelor’s degree and later a law degree. The loan amount ballooned to $221,000 by 2018, when he filed for Chapter 7 bankruptcy in New York. Mr. Rosenberg sought to have the student loan debt discharged in the bankruptcy because it would impose an undue hardship on him. Mr. Rosenberg was working, was not defrauded, and was not disabled when he sought the discharge of the student loan debt.

Mr. Rosenberg sued to have the student loan debt discharged in the bankruptcy proceeding. Surprisingly, the bankruptcy judge hearing his case ruled that he did not have to repay his student loans because repayment would cause him an undue financial hardship.

Student loans are notoriously difficult to discharge in bankruptcy. There are a few exceptions, including disability and undue financial hardship. The conditions for a discharge due to financial hardship are enumerated in the so-called Brunner test, which is used today in most federal circuits. The Brunner test is comprised of 3 factors: i) a debtor cannot maintain a minimal standard of living for herself and dependents based upon current income and expenses; ii) that additional circumstances exist that indicate the debtor’s state of affairs is likely to continue for a significant portion of the term of the student loan; and iii) the debtor has made a good-faith effort to repay the loan. The bankruptcy judge found that the Brunner factors were met and ordered Rosenberg’s student loan debt discharged.

It is important to emphasize that this is one bankruptcy court case, which is likely to be appealed. Whether this ruling is later affirmed on appeal or adopted by other courts remains to be seen. Regardless, the decision is a ray of hope in an otherwise very bleak and depressing area of bankruptcy law.

You may read the court’s opinion here.

UTMA Account Seized in Bankruptcy – What Can We Learn?

Uniform Transfers to Minors Act (UTMA) accounts are a popular tool for gifting assets to minors. They can easily be set up without the services of an attorney or accountant. A contribution to an UTMA account is considered a completed gift for tax purposes, but the minor beneficiary is prohibited from accessing the funds in the account until their 18th (or even 21st) birthday.

The account is managed and controlled by a custodian, who can be the minor beneficiary’s parent, guardian, or some other responsible adult. Once an UTMA account is created, any funds or other property transferred to the account cannot be returned to the person making the gift. When the minor reaches age 18 or 21, depending upon the state in which the account was created, he is entitled to access the funds in the account.

However, UTMA accounts are not without their drawbacks. Like other planning tools, unforseen circumstances can arise that defeat the good intentions of the gift maker.

One such example is illustrated in a recent bankruptcy case out of Rhode Island, In re Marcus Soori-Arachi. In 1998, when Marcus was 15, his father purchased an UTMA annuity for him with Fidelity in Nebraska. Under Nebraska law, the UTMA annuity should have terminated when Marcus turned 19 and the proceeds distributed to him. However, Marcus’s 19th birthday came and went and the account went undisturbed for another 10 years.

In 2017 Marcus, then married and living in Rhode Island, filed a petition for bankruptcy under Chapter 7 of the bankruptcy code. As required by bankruptcy law, the trustee appointed to administer Marcus’s case began the process of gathering and liquidating all of Marcus’s non-exempt assets.

The case trustee notified Fidelity that the UTMA annuity (now worth $105,000) should be turned over to the trustee. Marcus objected in the bankruptcy court, arguing that the UTMA annuity was not part of his bankruptcy estate and could not be liquidated by the trustee. (Marcus did claim a basic exemption protecting about $6,500 from the trustee.)

The bankruptcy court disagreed, finding that the UTMA annuity belonged to Marcus when he turned 19. The court ruled that it did not matter that the annuity was still in the account as of the date Marcus filed bankruptcy. Under Nebraska’s UTMA law, the custodial nature of the account terminated on his 19th birthday. Marcus gained an immediate right of ownership, possession, and control of the annuity, regardless of whether he actually exercised that right. The UTMA annuity could not be sheltered from his creditors in bankruptcy.

While this case interpreted Nebraska law, a bankruptcy court interpreting Michigan law would reach the same conclusion. While Michigan law protects the proceeds of an annuity from the claims of the creditors of a beneficiary, it does not protect the annuity proceeds from the claims of the creditors of the annuity owner, which Marcus became at age 19.

The facts of this case are unusual in that the annuity remained untouched in the UTMA for so long after Marcus reached age 19. When Marcus turned 19, he more than likely didn’t have any debts. But as time went on, he acquired a debt burden that grew to the point that he had to seek bankruptcy court protection, losing about $99,000 in the process.

Still, the case serves as an important reminder for those of you planning your estates. How well do you really know your children or other beneficiaries? Do they have excessive debt? Have they filed bankruptcy in the past? Are they being sued, or is a lawsuit threatened? What about a divorce – is a child’s marriage on the rocks? Knowing the answers to questions like these can help you structure or revise your estate plan, including beneficiary designations, to protect an inheritance from being lost to a beneficiary’s creditors.

The bankruptcy court’s opinion can be accessed here.

A New Estate Planning Tool – The Michigan Asset Protection Trust

On February 5, 2017, Michigan became the 17th state (along with Delaware, Nevada, Ohio, and others) to permit residents to use asset protection trusts in their estate planning. Michigan’s new law, the Qualified Dispositions in Trust Act (the “Act”), allows an individual to create an irrevocable trust known as a domestic asset protection trust (DAPT) that, if set up correctly, will shield the trust’s assets from the claims of the individual’s creditors.

Until recently, asset protection trusts were available only in foreign (offshore) jurisdictions. The Bahamas, Bermuda, the Cook and Cayman Islands, Nevis, and several other jurisdictions developed highly favorable asset protection legal environments featuring sophisticated banking and trust services for clientele. Offshore asset protection statutes typically feature very short statutes of limitations periods for creditors to attack the trust, high burdens of proof for creditors, and require the creditor to challenge the trust in the jurisdiction of the trust’s location. However, with our federal government closely scrutinizing transfers of money away of the U.S., DAPTs are become more popular here in the states. In 1997, Alaska became the first state to enact a DAPT law for Alaska-based trusts.

Under the Act, a Michigan DAPT must be irrevocable, it must have a trustee located in Michigan, and, while the person who creates the trust (the “grantor”) may be a beneficiary of the trust, the grantor cannot have unrestricted access to the trust’s assets.

If a Michigan DAPT is set up correctly, a grantor’s creditors will be prohibited from reaching the trusts assets if the creditor brings a claim more than two years after the assets are placed into the trust. (A longer period applies to claims brought in bankruptcy.)  A Michigan DAPT cannot be created to defraud one’s existing creditors. Therefore, the trust must be created and funded before creditor claims arise.

The Michigan DAPT will be a useful planning tool for people with significant exposure to creditors, such as business owners and those engaged in high-risk professions, such as doctors and lawyers, where insurance may not offer adequate claim protection. A DAPT will not generally be suitable in a typical estate plan.

Post-Bankruptcy Mortgage Modification

A client contacted me regarding a potential home mortgage loan modification. The client had filed a Chapter 7 bankruptcy two years ago and received a discharge of all of her debts, including the mortgage loan debt. She wanted to pursue a loan modification under the federal government Home Affordable Modification Program, the “HAMP” program. Her concern was that by agreeing to a modification of the mortgage loan now, she would become personally liable for the mortgage debt that had been discharged in her bankruptcy.

If you file a consumer bankruptcy, you have the option to reaffirm (reinstate) a debt that would otherwise be discharged in the bankruptcy. By reaffirming a debt in bankruptcy, you remain personally liable for the debt after the bankruptcy, which means that if you later default on the debt, the creditor can sue you and recover the money owed through garnishment or other action. In general, bankruptcy lawyers do not recommend clients reaffirm debts since the point of bankruptcy is to shed the personal liability for the debts.

But what if, like my client, you didn’t reaffirm a mortgage debt in bankruptcy and later want to modify the loan. Does the mortgage modification reinstate the personal liability for the mortgage loan debt?

Even if you did not reaffirm your mortgage in your bankruptcy, you can work with your lender on a HAMP mortgage modification post bankruptcy, and the modification does not revive the personal liability for the discharged debt. The current HAMP Handbook, version 4.5 states that “Borrowers who have received a Chapter 7 bankruptcy discharge in a case involving the first lien mortgage who did not reaffirm the mortgage debt under applicable law are eligible for HAMP.” In addition, the following language must be included in the mortgage modification agreement: “I was discharged in a Chapter 7 bankruptcy proceeding subsequent to the execution of the Loan Documents. Based on this representation, Lender agrees that I will not have personal liability on the debt pursuant to this Agreement.”  Furthermore, Section 524 of the U.S. bankruptcy code prevents a debtor and a creditor from entering into any reinstatement agreement after bankruptcy for a debt that was discharged in bankruptcy.

A HAMP mortgage modification does not create a new loan  It changes the terms of the mortgage loan, and you are not agreeing to again be personal liable for the debt. (The only instance where personal liability on a modified loan survives bankruptcy is if you reaffirmed it during the bankruptcy.)

Understand that a loan modification is entirely different from a post-bankruptcy mortgage refinance, where an entirely new loan is being created after the bankruptcy. In that situation, you would have personal liability on the loan because it is a new debt that arose after the bankruptcy.

The HAMP morgage modification program is scheduled to expire December 31, 2016.

My Divorce Judgment Says My Ex Has to Pay a Joint Credit Card Debt, Why is the Bank Coming After Me?

I get calls from people who are being sued by banks or other creditors for joint debts that their ex spouse agreed to pay as part of their divorce. The question they ask: “If the divorce judgment says my ex is supposed to pay this debt, why is the bank coming after me?” They assume that since the divorce judgment says their ex has to pay the debt, they are no longer responsible.

A recent decision of the Michigan Court of Appeals illustrates a common misconception concerning the division and assumption of debts and liabilities in divorce judgments. The facts: Rod and his ex-wife, Kimberly, obtained a home equity loan from their credit union in 2003. In October 2011, the credit union sued them for nonpayment. The trial court entered default judgments against Kimberly and Rod in 2012. A few months after, Kimberly and Rod divorced. Their divorce judgment ordered Kimberly to pay the credit union debt and indemnify Rod against the debt. In June 2013, the trial court issued a writ of garnishment against Rod. Rod objected to the writ on the basis that Kimberly assumed the debt in the divorce judgment, which Rod argued absolved him of any liability on the debt. After a hearing, the trial court sustained Rod’s objections, holding that the divorce judgment precluded the credit union from seeking garnishment against Rod.

Now, most of you are probably thinking “that sounds right.” After all, Kimberly agreed to pay the debt, why should Rod be liable. On appeal, the Court of Appeals reversed the trial court, finding that Rod was still liable on the credit union debt though Kimberly had agreed to pay it. How can that be?

Well, like a lot of legal issues, it’s complicated. You see, the credit union was not a party to Rod and Kimberly’s divorce. And because of that, the credit union was not bound to the terms of their divorce judgment. Legally, BOTH Rod and Kimberly were still liable to the credit union, regardless of the terms of the divorce judgment.

Rod does have a remedy: the divorce judgment’s indemnity clause. An indemnity clause shifts the loss from the party forced to pay a debt (Rod) to the party who should have paid it (Kimberly). Rod has the right to sue Kimberly to reimburse him for any money he may have to pay the credit union.

So, what does this all mean for you?

  • First, even though your ex agreed to assume payment of a joint debt, that agreement doesn’t absolve you of your liability as to the creditor holding the debt. If your ex defaults on the payments, the creditor can still go after you for full payment.
  • Second, indemnity clauses in divorce judgments are important. If your ex stops making the payments and the creditor sues you, you can go after your ex to reimburse you for your loss. An indemnity clause may still be enforceable if your ex files bankruptcy.
  • Third, be vigilant. The time to find out your ex has stopped paying a debt is not when the process server is pounding on your door. Keep an eye on your credit report to see if your ex has been paying late, or or has stopped paying altogether. You can take your ex to court to enforce the agreement before the creditor comes calling.

The case is DFCU v Monts. You can access the Court of Appeals opinion here.

What The Heck? I Collected Unemployment Benefits Last Year And Now The State Wants Me To Pay Them Back!

A colleague of mine told me about a recent call from a person who had received unemployment benefits last year, and now the State of Michigan has sent him a notice he was overpaid and is demanding return of the overpayment amount, with fines and penalties to boot.  The caller explained that he was back to work, but was barely making ends meet.  He wanted to know what he could do.

The State may demand return of just a portion of the benefits paid because of a calculation error for instance (I know, even if it’s not your fault), or it may demand return of all of the benefits paid because the State has determined that the recipient was not eligible to receive unemployment benefits in the first place.  Unfortunately this is a fairly common situation – and people are oftentimes still unemployed, or are back to work making less money than before (and they have other debts accumulated while unemployed) – when the State sends them a repayment demand.  If you are in that situation, what can you do, and will bankruptcy help?  Can you include the overpayment amount as a dischargeable debt in bankruptcy?

A lot depends upon whether you are still receiving benefits.  If you are, the State can recoup the overpayment from you by reducing your future benefits until the overpayment is recovered. In this situation, a bankruptcy will not help. Generally, when you file bankruptcy all creditor enforcement actions are stayed, or stopped, by order of the bankruptcy court.  However, the bankruptcy stay does not extend to the recoupment of an overpayment.  So, if you are still collecting benefits and the State has reduced future payments to recoup the overpayment, bankruptcy will not help.

What if you are no longer receiving unemployment benefits, will bankruptcy help you?  Again, it depends.

If you are no longer receiving unemployment benefits, the overpayment amount is treated as an ordinary debt that’s owed to the State.  In this case, the overpayment amount is dischargeable in either a Chapter 7 or a Chapter 13 bankruptcy, with one big exception: if you obtained the benefits by fraud.  Under the bankruptcy code, if you committed fraud to obtain the benefits, then the overpayment debt will not be dischargeable in bankruptcy.

Okay, let’s say the overpayment amount is dischargeable (no fraud), you may still be facing fines and penalties.  What about those?  Fines and penalties are dischargeable in a Chapter 13 bankruptcy; they are not dischargeable in a Chapter 7 bankruptcy.

As with any serious legal matter, you should carefully assess your situation with an experienced attorney to determine whether bankruptcy may be an appropriate solution if faced with a demand from the State to recover an unemployment benefit overpayment.



4 Key Rule Changes Affecting Retirement Accounts You Need to Know.

What you don’t know can hurt you. And this truism is never more apt than when it comes to the rules governing retirement accounts. Several rule changes took effect recently that will have a significant impact on traditional and Roth IRAs, and employer sponsored retirement plan accounts. Individuals who own these types of accounts must become familiar with the following new rules now:

1. As of January 1, 2015, IRA owners are limited to one rollover per year.

Under this new IRS rule, an IRA owner can take a distribution from an IRA and roll it over into another IRA account only once per 12 month period, regardless of how many IRA accounts he may own. This rule aggregates traditional IRAs and Roth IRAs together, so one cannot perform a rollover between traditional IRAs and then perform a rollover between Roth IRAs within the same 12 month period. This is a significant change to the way the IRS has treated multiple rollovers generated by a 2014 United States Tax Court decision. Violate this rule and the second rollover will be treated as a taxable distribution, which will result in the imposition of income taxes (and the dreaded 10% early withdrawal penalty if the account owner is younger than age 59½).

Excepted from this new rule are direct trustee-to-trustee transfers, rollovers from employer sponsored qualified plans [such as 401(k), 403(b), etc.], and Roth conversions.

2. Inherited IRAs are not protected in bankruptcy.

In 2014 the United States Supreme Court ruled that funds in an inherited IRA are not protected in bankruptcy from the claims of the IRA beneficiary’s creditors unless a state law provides a specific exemption (currently only a few states provide this type of exemption, and Michigan isn’t one of them). Individuals with larger IRA or qualified plan account balances may need to rethink their retirement account beneficiary designations in light of this ruling. In circumstances where a child or other beneficiary may have financial trouble, it may be prudent to make other arrangements to enhance creditor protection for inherited account balances.

3. QLACs get the go-ahead.

What is a “QLAC?” It is a qualified longevity annuity contract, which can enhance income security for those  who may be worried about outliving their money in retirement. These deferred income annuities can be purchased through IRAs and qualified plans (within limits) and the contract values will be exempt from RMD rules until age 85, when distributions from the QLAC must begin. A QLAC will do two things: First, distributions from the account can be delayed until age 85, thus allowing for greater tax deferred growth and guarantying an income stream for life; and second, the value of the annuity will be excluded when calculating required minimum distributions (RMD) from other retirement accounts (and the payments from the QLAC are assumed to satisfy its RMD obligation).

To be eligible, a QLAC must meet the following criteria: i) Investment in the contract is limited to the lesser of 25% of all pre-tax retirement account balances aggregated together, or $125,000 (indexed for inflation); ii) The QLAC must begin its pay outs no later than age 85; iii) The QLAC must be irrevocable and illiquid (no cash-surrender value), but it can provide for a return-of-premium death benefit payable to heirs as a lump sum or life-contingent survivor annuity; and iv) it must be a fixed income annuity – variable annuities, indexed annuities, and similar type annuities will not qualify.

4. IRS Notice 2014-54 allows for the tax-free conversion of after-tax funds from a 401(k) account to a Roth IRA.

Under this IRS Notice, the IRS confirms that individuals with both pre and after-tax money in an employer sponsored retirement plan can convert the after-tax money to a Roth IRA tax free. However, one may not simply take out the after-tax money for the Roth conversion and leave only pre-tax money behind in the employer plan. If they do, the IRS will apply the traditional pro-rata rules to the distribution.

The rules governing IRAs and other retirement accounts are very complex and tricky. Even seemingly simple transactions involving an IRA or other retirement account can result in disastrous tax consequences. And the Internal Revenue Code is extremely unforgiving. Before making any move with any type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.

“I Don’t Want To Include My House In My Bankruptcy!”

And so began my conversation with a caller who wanted information regarding bankruptcy. He explained that he and his wife are afraid they will lose their house if their lender discovers they filed for bankruptcy.

What bankruptcy filers sometimes don’t understand is that under the bankruptcy code, all of their assets and debts must be included in the bankruptcy case. The law requires a debtor (the person who files bankruptcy) to disclose all of their assets and debts on their bankruptcy schedules filed with the court. It is a violation of federal law to do otherwise, and failure to include all assets and debts could result in bad things happening to them, including denial of a bankruptcy discharge, or criminal prosecution and prison for bankruptcy fraud. So, regardless of the asset or the debt (or whether one wants to include it or not), it must be included in the bankruptcy.

But, one doesn’t automatically lose a house or car merely because they file bankruptcy. The vast majority of debtors are able to keep key assets like homes and vehicles after bankruptcy as long as they keep current on the payments (though car loans are a bit trickier). Post bankruptcy payments will reduce the outstanding lien balance so that when the lien is completely paid off, a mortgage lender will issue a mortgage discharge, and a vehicle lien holder will issue a lien release, in either case removing the lien from the asset title.