Generally, retirement plan benefits are excluded from a bankruptcy estate. However, if the retirement plan is not covered by Title I of the Employee Retirement Income Security Act of 1974 (ERISA), a separate exemption from the bankruptcy estate must be found. Some retirement plans are not covered by Title I of ERISA because they do not cover employees, which, for this purpose, excludes the sole owner of a business and the owner’s spouse. These types of plans are commonly referred to as “Keogh” plans.
A recent case in the U.S. Court of Appeals for the Tenth Circuit provides some additional guidance in this area. The doctor in this case had a medical practice in Utah and adopted a plan intended to be a qualified plan under Internal Revenue Code §401(a) (IRC).
It is important to note that the State of Utah has elected not to adopt the federal bankruptcy rules defining which property is exempt from a bankruptcy estate, and has instead adopted its own set of rules. Under Utah’s exemption provisions, any money or other assets held or payable to a debtor where the debtor is a participant and beneficiary in a retirement plan or arrangement that is described in IRC § 401(a) is exempt from execution by creditors and would therefore be exempt from the bankruptcy estate.
During the period in which the doctor operated the Keogh plan, numerous operational errors occurred. An expert witness testified that many of the errors were significant, and that the Keogh plan was defective and therefore disqualified from receiving special tax treatment awarded to qualified plans under IRC § 401(a). Based on this information, the bankruptcy trustee objected to the claimed exemption of the funds held in the Keogh plan. Both the bankruptcy court and the district court disagreed, determining that most of the funds were exempted from the bankruptcy estate. The Tenth Circuit affirmed the lower court opinions, finding that the Utah statute applied to retirement plans if they “substantially complied” with IRC § 401(a). The expert witness had also testified that the errors in the operation of the Keogh plan fell within the scope of the Employee Plan Compliance Resolution System of the Internal Revenue Service and could, therefore, be corrected. Because the operational errors could be corrected, the Tenth Circuit found that the plan substantially complied with the requirements of Section 401(a) and fell within Utah’s exemption provision. (Gladwell v. Reinhart [In re Reinhart], 10th Cir. 2012)