Merrill Lynch IRA Account Still Exempt From Bankruptcy

Your employee IRA accounts are still safe under Chapter 7 Bankruptcy, according to a decision by the Sixth Circuit on Monday.

The Daley v. Mostoller Court reaffirmed common knowledge in bankruptcy practice, that individual retirement accounts (IRAs) are "off limits from tax collectors and creditors in bankruptcy," unless they've been used in a prohibited way.

What does the Sixth Circuit consider a prohibited use of an IRA?

Exemption Presumption

As with James Daley, during a declaration of Chapter 7 bankruptcy, a bankruptcy trustee will peruse your assets, including any IRAs, and cry foul to the bankruptcy court if you've been inappropriately squirreling away money.

There is a statutory exemption for IRAs pursuant to 11 USC § 522(b)(3)(C) which exempts all retirement funds which are tax exempt.

Daley's Merrill Lynch IRA account was given the green light/thumbs up by the IRS, who certified the account as tax exempt, yet the bankruptcy and district federal courts found the account to not be exempt.

Collateral Provision

The bankruptcy trustee originally had a beef with a liens provision in his IRA agreement which gave Merrill Lynch lien access to his IRA and other properties in order to satisfy future debts to Merrill Lynch.

The crux of the issue was whether this future lien agreement was in effect a future extension of credit, which would destroy the IRA's tax exempt status pursuant to the tax code. It seems like most securities firms, not just Merrill Lynch, would ask this sort of thing of their IRA investors, which if construed as a future credit would destroy all IRA tax exemption benefits.

This is of course why it cannot be true.

Possible Lien Isn't Really A Lien

The Sixth Circuit agreed that this was a pretty ridiculous road to go down, and despite speculation about what might have happened in Daley's case, there was no extension of credit or lien to speak of.

Although the Court has occasionally considered cases of future injury, like for victims of child molestation, it isn't going to consider IRAs with this provision all subject to Chapter 7 bankruptcy due to possibilities of future liens.

A good takeaway might be: if an agency as notoriously persnickety as the IRS says your assets are alright, you should be fine in bankruptcy court.

Related Resources:

• Guardian Ad Litem Fees are Nondischargeable in Bankruptcy (FindLaw's U.S. 6th Circuit Blog)
• Fired Employee's Discrimination Claim Belongs to Bankruptcy Estate (FindLaw's U.S. 6th Circuit Blog)
• Exempt vs. Non-exempt Property Under Chapter 7 (FindLaw)
• The FindLaw Guide to Chapter 7 Bankruptcy (FindLaw)