Synopsis: The Missouri General Assembly has allowed complete exemption of the traditional Individual Retirement Account. The Roth IRA, created by the Taxpayer Relief Act of 1997, does not fit into the statutory scheme of IRA exemptions and is subject to claims of creditors and bankruptcy trustees.
With the passage of the Taxpayer Relief Act of 1997,1 Roth IRA's were created as an attractive retirement option. Many articles have been written regarding the use of a Roth IRA as a financial planning tool. The traditional IRA allows tax deductible contributions to be made to the IRA, all of which, however, are fully taxable when the funds are later withdrawn.2 The Roth IRA is the reverse. With a Roth IRA there is no deduction when the contribution is made but, subject to certain restrictions, funds can be withdrawn without tax or penalty.3 Additionally, because the Roth IRA has no minimum distribution requirements and is not subject to income tax, it has the advantage of favorable use as an asset to fund a credit shelter trust in an estate plan. But hidden within all of the advantages to the Roth IRA lurks a trap for the unwary: It is subject to claims of creditors.
In recent years there has been a great deal of litigation in Missouri bankruptcy courts and United States Courts of Appeals arguing the extent to which pension plans and IRAs were exempt from claims of creditors.4 At one time there was a split between the bankruptcy courts of the Eastern District5 and the Western District6 of Missouri as to whether pension plans were exempt from claims of creditors under state law or if Missouri statutes were preempted by ERISA. That controversy was decided in In re Vickers,7 the 8th Circuit holding that ERISA did not preempt state law and qualified pension plans were exempt.
The United States Supreme Court later issued its mandate in Shumate v. Patterson declaring ERISA was a non-bankruptcy exemption and that no trustee or other creditor had the right to attach or claim assets under an ERISA plan which was qualified under the Internal Revenue Code.8 Shumate seemed to signal an abrupt end to the controversy over the protection of retirement benefits against claims of creditors and trustees. Missouri responded in 1998 with Senate Bill No. 447, incorporated into § 513.430(10)(f), RSMo. This bill, signed into law by then Governor Ashcroft, exempts all assets, regardless of need, in any retirement plan qualified under §§ 401(k), 403(a)(3), 403(b), 408, or 409 of the Internal Revenue Code.9 Particularly important is the reference to § 408, because that statute embodies the traditional IRA.
In spite of the new law codified at § 513.430(10)(f), certain creditors and trustees continued to claim IRAs were not really pensions but were simply accounts. However, in In re Mehra, the United States Bankruptcy Court for the Eastern District of Missouri made quick work of that argument, ruling § 513.430(10)(f) meant exactly what it said, and a traditional IRA established under the Internal Revenue Code was completely exempt from claims of a trustee in bankruptcy.10 The court in Mehra cared not at all that the establishment of IRAs was outside the preemptive scope of ERISA because the Missouri legislature's definition of "retirement plan" was not drawn from that federal act.11 Mehra held Missouri IRAs were exempt, and all practitioners thought the issue was finally resolved. But now the Roth IRA poses a new challenge.
Unlike the traditional IRA found exempt in Mehra, the Roth IRA was not created by I.R.C. § 408. The genesis of the Roth IRA is § 408A. The Missouri statute relied on in Mehra exempts § 408, but there is no subsection called 408A. Rather, the Roth IRA created in I.R.C. § 408A is its own enactment.12 Plainly, the Roth IRA is not exempt in Missouri.
The 89th Missouri General Assembly reacted to this anomaly by enacting House Bill No. 1744 to repeal § 513.430 and establish a new statute with a specific reference to I.R.C. 408A. In other words, the Missouri General Assembly sought to amend the statutory exemptions to include the Roth IRA. Governor Carnahan vetoed House Bill No. 1744.
Since the enactment of the Roth IRA, articles have been written and seminars held touting the benefits of a rollover from the traditional IRA to the Roth IRA.13 Any Missouri attorney who counsels clients with a high liability exposure may wish to also consider in the equation that when all the numbers are finally crunched and spreadsheets presented, the Roth IRA is not now exempt from claims of creditors or bankruptcy trustees. Perhaps the next Missouri General Assembly will try again to amend § 513.430 to include the Roth IRA, and perhaps the governor will sign the bill.
Endnotes
1 Taxpayer Relief Act of 1997 §302(a), adding I.R.C. 408A. For a good topical review of the tax benefits of a Roth IRA, see James L. Dam, The Roth IRA: A Tax Break That's Too Good to be True?, 97 LWUSA 733.
2 I.R.C. 402(d).
3 I.R.C. 408A(d)(1)(A).
4 For example, In re Graham, 726 F.2d 1268 (8th Cir. 1984), holding ERISA was not federal, non-bankruptcy exemption to protect IRA. See also, Andrew M. Campbell, J.D., Individual Retirement Accounts as Exempt Property in Bankruptcy, 133 A.L.R. Fed 1 (1996).
5 In re Wallace, 66 Bankr. 834 (Bankr. E.D. Mo. 1986).
6 In re Gaines, 106 Bankr. 1008 (Bankr. W.D. Mo. 1990).
7 954 F.2d 1426 (8th Cir. 1992).
8 504 U.S. 753 (1992).
9 See also § 513.430(10)(e)c provides as exempt a person's right to receive reasonably necessary payments under a pension, profit sharing, or non-public retirement plan (among others) unless the plan or contract does not "qualify under §§ 401(a), 403(a), 403(b), 408 or 409 of the Internal Revenue Code of 1954 (26 U.S.C. §§ 401(a), 403(a), 403(b), 408 or 409). . . ." Emphasis is author's. See also Federal Bankruptcy Exemption, 11 U.S.C. § 522(d)(10)(e) upon which Missouri's statute is based.
10 166 Bankr. 393 (Bankr. E.D. Mo. 1994).
11 Mehra, supra at 398.
12 Taxpayer Relief Act of 1997 § 302(a).
13 For excellent nationwide review of exemption or lack of exemption of Roth IRA, see James L. Dam, 'Roth IRA' May Not Be Protected From Creditors, 98 LWUSA 97.
Mr. Checkett is a member of the firm of Checkett & Pauly in Carthage, Missouri. He has a general civil practice which includes commercial and bankruptcy litigation.
1999, Kevin Checkett