Walsh v. Dively, 551 B.R. 570 (W.D. Pa. 2016)
Facts: When husband and wife were divorced in Pennsylvania, they agreed that the wife would receive 50% of the husband’s retirement. The agreement was incorporated into the divorce decree, but no DRO was entered.
The wife then filed for Chapter 7 bankruptcy. The bankruptcy trustee moved in bankruptcy court for authority to ask the state court to issue a DRO. The bankruptcy court denied the motion. The trustee then appealed.
Issue: Should the trustee be permitted to seek a DRO?
Answer to Issue: No
Summary of Rationale: The trustee has a duty to collect property of the estate in bankruptcy. But retirement plans with an antialienation provision are not part of an estate in bankruptcy. Patterson v. Shumate, 504 U.S. 753 (1992). The retirement plan at issue was governed by ERISA, and it was subject to the statutory antialienation provision in ERISA unless a QDRO was entered. Because a DRO had not even been entered, let alone qualified by the plan, there was no QDRO, and the antialienation provision remained operative. Thus, the pension was not part of the wife’s estate in bankruptcy.
Note: As we shall shortly see, it is quite important that the state court awarded the wife an actual interest in a retirement plan, and not an award of cash she could spend freely for any purpose.
In re Kizer, 539 R. 316 (Bankr. E.D. Mich. 2015)
Facts: In a consent judgment of divorce, a court awarded the husband 50% of three retirement accounts owned by the wife. The wife was also awarded the marital home, but required to pay the husband for his interest. Because she lacked the funds to make the payments, she agreed to pay for the home by giving up her interest in the requirement accounts, increasing the husband’s interest to 100%.
QDROs were subsequently entered and approved, directing the administrators of the accounts to transfer to the husband 100% of the balance of certain accounts. The plan administrators complied with the QDROs by giving the husband accounts containing the funds at issue. A finding of fact was made that the husband could make withdrawals from these accounts at any time, without any form of early withdrawal penalty. (The husband claimed that his withdrawals were subject to a penalty, but he failed to produce supporting evidence, even after the court gave the husband additional time.)
The husband subsequently declared bankruptcy. Bankruptcy law allowed him to claim an exemption for “retirement funds.” The husband claimed that the exemption covered the funds paid to him by the wife.
Issue: Was the husband entitled to the exemption?
Answer to Issue: Yes
Summary of Rationale: The court faced a question of first impression. The closest authority found was Clark v. Rameker, 134 S. Ct. 2242 (2014), which held that the retirement funds exemption did not apply to an inherited IRA. The Supreme Court stressed that the inherited funds were not limited for use after retirement but, rather, were freely available to be spent for any purpose. The Supreme Court also stressed that the beneficiary of the inherited funds could not make new deposits into the inherited IRA.
The court held that the accounts before it were similar to the accounts in Clark. The husband could not deposit money into them, and he could withdraw funds freely from them, without penalty. Because the accounts were not reserved in any way for use after retirement, they were not covered by the bankruptcy exemption for “retirement funds.”
The key difference between Walsh and Kizer is that the wife in Walsh received an interest in retirement benefits, while the wife in Kizer essentially received cash. Retirement benefits are not part of the alternate payee’s estate in bankruptcy; cash is part of the recipient’s estate in bankruptcy.
When a divorce settlement transfers funds to a spouse who may potentially declare bankruptcy in the future, it would be prudent to take those funds in the form of a retirement account. If they must be paid in cash, the alternate payee should roll the transferred funds over into an account specifically marked for retirement use, and ideally subject to early withdrawal penalties. Otherwise, there is a risk that a bankruptcy court might treat the funds as general cash and not as retirement benefits.