Retirement Savings and Bankruptcy: Recent Developments
Prof. Marianne B. Culhane
ABI Robert M. Zinman Resident Scholar
ensions are getting a lot of press of late. Bills aimed at protecting pensions from underfunding and retirement
funds from creditors in bankruptcy are plentiful in legislative inboxes. In this month's Update, we'll look at the
pension-related provisions of H.R. 975, this year's version of the omnibus bankruptcy reform bill passed by the
House in March, but so far stalled in the Senate.1 We'll also briefly review the current controversy on how to
calculate employer contributions to defined benefit plans, to keep those plans adequately funded without
H.R. 975: Retirement Savings Under the Bankruptcy Reform Bill of 2003
H.R. 975 would increase protection of debtors' retirement savings in bankruptcy through a new uniform
exemption. It would also allow chapter 13 debtors to contribute to pension plans and repay pension fund loans
during their bankruptcy case, putting them on a par with chapter 7 debtors. These proposals clearly favor
preservation of retirement earnings as against payment of pre-petition creditors, perhaps surprising in a bill generally
viewed as creditor-friendly. Of course, these provisions will benefit higher-income debtors who tend to have
retirement savings and not the many whose retirement plans are limited to Social Security expectancies.
Uniform Bankruptcy Exemption for Tax-favored Retirement Funds
Under current law, interests in most employer-sponsored pension plans are completely excluded from the
bankruptcy estate.2 In Patterson v. Shumate,3 the Supreme Court held that tax-exempt plans covered by Title I of
the Employee Retirement Income Security Act (ERISA) are trusts within the meaning of Code §541(c)(2) because
ERISA anti-alienation provisions are "enforceable under applicable non-bankruptcy law." A debtor's interest in such
plans is entirely excluded from the estate, without dollar limit or proof of necessity for support. Even an employee's
excess contributions not qualifying for tax deduction are excluded from the bankruptcy estate.4 H.R. 975 would
facilitate this exclusion by amending §541 to exclude from the estate dollars withheld from a debtor's wages or
transferred by the employee to the employer for deposit in an ERISA plan.
Some common forms of retirement savings, however, are not covered by ERISA's Title I, and thus not
excluded from the estate under Patterson. To protect Individual Retirement Accounts (IRAs) and interests in
government and church-sponsored plans, for example, debtors currently must look to state or federal exemptions.
These exemptions vary in coverage and amount and, like §522(d)(10)(E)'s federal bankruptcy exemption, may be limited to amounts "reasonably necessary for the support of the debtor," a
potentially troublesome question of fact. Most courts allow exemption of IRAs, but some refuse since the debtor
has access to the funds regardless of her age (although early withdrawals get a 10 percent penalty and regular income
treatment). Compare In re Skipper,5 where the U.S. Bankruptcy Court for the Western District of Arkansas held that
the debtor's access means IRAs are not exempt, with In re Burkette,6 where the U.S. Bankruptcy Court for the
District of Colorado held that IRAs are exempt despite being under debtor control. State exemption statutes raise
similar interpretive difficulties.
H.R. 975 would leave in place the ERISA plan exclusion under Patterson and existing state and federal
exemptions for retirement plans. However, the bill would create a new uniform bankruptcy exemption that should
be simpler and more certain than current exemption statutes. The new exemption would protect "retirement
funds...in a fund or account that is exempt from taxation" under Internal Revenue Code (IRC) §§401, 403, 408,
408A, 414, 457 or 501(a). Any debtor could use this exemption, regardless of state opt-out or choice of state vs.
federal exemptions.7 The debtor would have to show only that the account or plan merits tax exemption, which is
presumed if the IRS has issued a favorable determination. If the IRS has not so acted, the exemption applies if there
is no adverse IRS or court decision and the plan substantially complies with the tax code.
The proposed uniform exemption has no "necessary-for-support" limit. Instead, there is a $1 million limit
for most IRAs (but not other plans), unless "the interests of justice" require an increase. This new exemption would
extend to rollovers and direct transfers from one retirement fund to another, and amounts rolled into an IRA would
not count against the million-dollar limit. This would sidestep cases like last year's Eighth Circuit BAP holding in
In re Rousey,8 denying exemption under §522(d)(10)(E) for an IRA funded entirely by dollars rolled over from
another exempt plan.
The question arises as to whether debtors could use (or abuse) this exemption to shelter large amounts
raised by eve-of-bankruptcy conversion of non-exempt property. Kenneth Cooper of the Pension Benefit Guaranty
Corp. suggests that the $3,000 annual limit on deductible IRA deposits would prevent this.9 Section 408(a)(1) of
the tax code provides that contributions in excess of the deductible amount "will not be accepted."10 Excess
contributions would put the IRA out of technical compliance, and presumably outside the "substantial compliance"
term of the proposed exemption.
Retirement Accounts in Chapter 13
The provisions covered so far would apply in both chapters 7 and 13. Other H.R. 975 proposals would
apply mainly in chapter 13, allowing debtors to continue contributions and repay plan loans during their case.
Chapter 7 debtors are already free to do both, since their post-petition earnings are not estate property under
§541(a)(6), and their employers may withhold post-petition earnings without violating the stay. Chapter 13 debtors,
however, are often denied the right to contribute to, or repay loans from, retirement accounts during their lengthy
cases. A chapter 13 debtor's earnings during the case are property of the estate under §1306 and disposable income
under §1325(b), which must be devoted to payments under the plan unless reasonably necessary for support.11
Thus, the Sixth Circuit refused confirmation of a plan proposing 100 percent repayment of an ERISA loan in In re
Harshbarger12 on the basis that the debtor should not be able to repay himself in preference to other creditors.
Further, some courts hold that since ERISA plan loans are secured by property excluded from the estate, the loans
are not claims payable to any extent in chapter 13.13
H.R. 975 would overturn Harshbarger and similar cases. First, the bill amends §541 to exclude from the
estate dollars an employer withholds or obtains from an employee for contribution to plans covered by Title I of
ERISA and a few other tax-favored plans. Second, it provides that such dollars are not disposable income under
§1325. Third, H.R. 975 amends §362(b) to allow employer withholding for repayment of retirement plan loans.
Taken together, these changes work a substantial change in chapter 13, allowing the debtor to continue to build up
retirement funds during the three to five years of the case.
When the Employer Is the Debtor
These H.R. 975 retirement plan provisions assume it is the employee who files bankruptcy. Section 446 of
the bill, however, covers the case of an employer as filer. That section amends Code §§521 and 1106 to require a
debtor who is also an ERISA plan administrator, or the bankruptcy trustee in such a case, to continue to carry out
his or her fiduciary duties under the plan during the case.
Calculating Employer Contributions to Defined Benefit Plans
Congressional concern with retirement savings is not limited, of course, to bankruptcy cases. Several bills
have been introduced proposing broad overhauls of pension protection, such as Sen. Charles Grassley's (R-Iowa)
NESTEG bill,14 approved by the Senate Finance Committee on Sept. 18, and Rep. Rob Portman's (R-Ohio) H.R.
1776, the Pension Preservation and Savings Expansion Act.
Most observers say there is little chance that these wide-ranging bills will be enacted in 2003. However,
prompt action is likely on the narrow question of the discount rate for calculating required contributions to defined
benefit plans. Because these plans require future payments of fixed amounts, present contributions are based on an
assumed rate of interest on pension investments. Basically, the higher the assumed interest rate, the lower the
necessary employer contributions.
Until recently, employers were required to use the relatively low 30-year Treasury bond rate, but the
Treasury stopped selling those bonds in 2001. A temporary fix will expire this year, and without further
congressional action, the rule will revert to a low, long-term Treasury rate. Employers would have to increase their
contributions, and that, they argue, would prevent new hiring and would generally slow economic recovery. Too
high a rate could convince employers not to offer defined benefit plans. The main areas of disagreement are (1) what
rate to use for the long-term and (2) how fast to phase in a new rate.
For the short and long term, employers generally favor a higher discount rate based on a blend of
investment-grade long-term corporate bonds, which they say better approximate likely future investment returns.
The Senate NESTEG bill would use the corporate rate only for the next three years. Thereafter, it would phase in a
rate favored by the Treasury Department, called a yield-curve. As described in the Treasury's July 8 press release, the
yield-curve takes into account the age of the workforce and thus the timing of eventual payouts. This formula would
require higher employer contributions than the corporate bond rate. If adopted, this rate would likely be phased in
over five or more years.
There is broader agreement on the use of the corporate rate for the short term before a permanent formula is
put in place. Rep. John Boehner (R-Ohio) introduced the Pension Funding Equity Act in late September requiring
use of the corporate bond rate for two years. Unlike the Senate's NESTEG bill, Rep. Boehner's proposal does not
determine the long-term solution. Rep. Boehner suggests it is premature to do so until Congress takes a "broader
look at the defined benefit system and considers permanent solutions to the pension underfunding problems that
will give working families and employers long-term certainty."15
1 That may soon change, as in mid-September, Senate Finance Committee Chair Charles Grassley (R-Iowa)
called for prompt Senate action on H.R. 975. Return to article
2 Cooper, Kenneth, "Protection of Debtors' Retirement Funds Under the Proposed Bankruptcy Bill," Norton
Bankruptcy Law Adviser 1 (Nov. 2002); Howard, Margaret, "A Primer on Pension Issues in Bankruptcy,"
www.abiworld.org/pensionarticle.pdf. Return to article
3 504 U.S. 753 (1992). Return to article
4 Barkley v. Conner, 73 F.3d 258 (9th Cir. 1996); Manufacturers' Bank & Trust Co. v. Holst, 197 BR 856
(N.D. Iowa 1996). Return to article
5 274 BR 807(Bankr. W.D. Ark. 2002). Return to article
6 279 BR 388 (Bankr. D. Colo. 2002). Return to article
7 See H.R. 975 (108th Cong.), §224(a), (m). Return to article
8 283 B.R. 265 (BAP 8th Cir. 2002); cf., Eibert v. Pelican, 162 F.2d 523, 527-28 (8th Cir. 1998). Return to article
9 Cooper, supra at 3-4. The annual limit will rise to $5,000 in 2008. Id. Return to article
10 26 U.S.C. §408. Return to article
11 See, e.g., In re Delnero, 191 B.R. 539 (Bankr. N.D.N.Y. 1996). Return to article
12 66 F.3d 778 (6th Cir. 1995). Return to article
13 See In re Villarie, 648 F.2d 810 (2d Cir. 1981). Return to article
14 The acronym stands for the National Employee Savings and Trust Equity Guarantee Act. As of this
writing, it has not been assigned a bill number, but a detailed summary is available on Sen. Grassley's web site. Return to article
15 Press release, Rep. John Boehner, Sept. 17, 2003. Return to article