What prevents folks from putting all their money into an IRA before filing?

[nozar]

Yes, there's an annual limit to IRA contributions, but if you contribute above that, it's a only 6% penalty. Far better than the 100% penalty of all your non-exempt money going into the bankruptcy estate.

Is this a huge loophole, or am I missing something? (If it's a loophole, feel free to delete this thread. Seriously.)

[shipo]

I rather doubt it is a loophole, that said, I have no substantive basis for feeling that, it is just a gut reaction to your question.

What I'm thinking is, attempting this type of an effort to shield money from a Trustee would fail in that the money above the maximum annual contribution would be clawed back by the Trustee. Furthermore, if you have no history of contributing to an IRA prior to now, my gut tells me the Trustee might could well attempt to claw back the full amount.

[justbroke]

It's not a loophole. It's no different than a Floridian buying an $8,000,000 house on the eve of bankruptcy.

But, there's more! The United States Trustee (UST) would likely file a complaint (AP/adversary proceeding) claiming that under the bad faith exception, that you did that on purpose to avoid your creditors. Okay, there's some nuance, and you can't technically do $8M on the eve of bankruptcy as there's a federal "cap" on homestead exemptions for the first 40 months of approximately $160,375 -- adjusted triennially.

Does Article X, Section 4 of the Florida Constitution exempt a Florida homestead, where the debtor acquired the homestead using non-exempt funds with the specific intent of hindering, delaying, or defrauding creditors in violation of Fla. Stat. § 726.105 or Fla. Stat. §§ 222.29 and 222.30 ?

Here's how that question was answered in Florida. In Havoco of America, Ltd. v. Hill, 790 So. 2d 1018 (Fla. 2001)), the Florida Supreme Court certified and answered the above question, yes! In my example, a Floridian could "hide" $160K in a home. Florida courts have said it's okay and doesn't violate the fraud statutes. The Florida Supreme Court actually overruled the bankruptcy court -- well remanded it -- and the Florida Bankruptcy Court came back and agreed with the Florida Supreme Court.

(Note: this may depend on the underlying State non-bankruptcy laws and possibly appellate law for the specific bankruptcy/district court.)

If you contribute both on the eve of filing and above the IRA contribution limit, the UST may also say that you did it purposefully to evade, hinder, delay, or defraud the creditors or the bankruptcy estate. That 6% could have gone to the creditors, so you see the issue there. The UST would probably even have a strong argument to combine the "bad faith" with the "totality of circumstances" complaint that the debtor is not deserving of a Chapter 7 discharge.

I would expect the UST to pushback and likely file a complaint for bad faith, a complaint for totality of circumstances, or both.

Bottom line, is that there are things that don't make sense, but constitutional rights (e.g. Florida's homestead exemption) and underlying State non-bankruptcy law may allow these eve of bankruptcy conversions!

[flashoflight]

nozar

IRAs are designed for deferring current employment income to retirement. Main purpose is not to shelter assets from creditors. In California, IRAs are notoriously poor for creditor protection in California outside of bankruptcy so most people actually use ERISA plans like 401k and pensions for asset protection. How much job income did you make in 2020 and how much will you make in 2021 on the job? That will dictate whether you can contribute $12k to an IRA for tax years 2020 and 2021 or not. If you have a job and still live in California, it's better to preferentially put it in the 401k if someone is suing you.

[womanonfire]

nozar

IRAs are designed for deferring current employment income to retirement. Main purpose is not to shelter assets from creditors. In California, IRAs are notoriously poor for creditor protection in California outside of bankruptcy so most people actually use ERISA plans like 401k and pensions for asset protection.

Looks like ERISA plans are treated differently than self directed or other type plans which doesn't seem fair.

nozar I was just reading your "rents" thread. Wishing you all the best in your unique situation.

[nozar]

nozar
Main purpose is not to shelter assets from creditors. In California, IRAs are notoriously poor for creditor protection in California outside of bankruptcy

I'm only looking at a Roth IRA for bankruptcy, so I should be OK? I haven't found more convenient legal vehicles to shelter assets from creditors in CA bankruptcy.

nozar
so most people actually use ERISA plans like 401k and pensions for asset protection.

That requires an employer to contribute, right? My employers haven't done that.

nozar
How much job income did you make in 2020 and how much will you make in 2021 on the job? That will dictate whether you can contribute $12k to an IRA for tax years 2020 and 2021 or not.

"Dictate" I think is misleading here? You can contribute over $6k/year, you just pay a 6% penalty on it **if** you don't withdraw that excess contribution by the tax filing deadline on October 15, 2021 for 2020, and October 15, 2022 for 2021. Plenty of time. I only want to contribute $6k/year though, to keep things simple.

As to how much I'll make in 2021, who knows, but I can contribute $6k now and make $6k until Dec 31st, 2021. Plenty of time.

I won't have time to file my 2020 return before filing for BK (and it's not required), so my IRA contributions won't show up there.

[flashoflight]

nozar The judge and trustee would very likely argue that the non tax favored Roth IRA contributions are fraudulent transfers because you didn't have employment income to make it tax favored. Remember the intent of retirement accounts is to defer current employment income for retirement, not to move cash around to hinder your creditors. I suppose you could contribute $6k for 2021, $0 for 2020, and promise you will earn employment income by the end of 2021. The judge and trustee would question your intention at the time of deposit but maybe they'll give you the benefit of the doubt. Maybe do a few Doordash deliveries to prove your intent to work and then deposit the full $6k and pinky promise the judge you will earn the rest later. That would look better.

In California, IRAs suck for asset protection unless you are inside bankruptcy. A creditor may grab your IRA beyond what you need to support yourself and your dependents. If you are 25 and you draw a bad judge, he may determine you can get a job and earn back 100% loss of the IRA with plenty of time before retirement. If you're 70, then the amount you need to live on from the IRA would become a factor. So high net worth folks like doctors with potential sue-happy patients will roll their IRA into their ERISA plans while employed or move out of California.

We are arguing about $6k of possibly fraudulent transfers to IRA but retirement accounts (ERISA only in California) are actually amazing for keeping large amounts of assets away from creditors. Many of us did the dumb thing to withdraw from 401k to keep the debt boat afloat when it was 100% protected at unlimited amounts. Or we didn't put much into our 401k because of debt. The best planned bankruptcies have debtors that have half a million in retirement or more that the creditors and trustees couldn't touch. OJ had his NFL pension that the Goldmans couldn't touch despite their huge judgment.