Sec. 403(b) Annuity Included in Bankruptcy Estate

E had a retirement account through an employer, which was a qualified annuity under Sec. 403(b). E filed a voluntary petition under Chapter 7 of the Bankruptcy Code and claimed that pension/annuity should be excluded from the bankruptcy estate under Section 541(c)(2). The Bankruptcy Court excluded the annuity, and the trustee appealed to the District Court.

Analysis

Section 541(c)(1) of the Bankruptcy Code broadly provides a bankruptcy estate includes “all legal or equitable interests of the debtor in property” as of the commencement of the bankruptcy estate “except as provided in subsections (b) and (c)(2) of this section.” Under Section  541(c)(2):

A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

The courts are in conflict over whether annuity pension plans that are tax-qualified under the provisions of  Sec. 403(b) should be excluded from a bankruptcy estate by Section 541(c)(2). In Patterson v. Shumate, 504 US 753 (1992), the Supreme Court held an antialienation provision in an ERISA-qualified pension plan constituted an enforceable restriction on transfer under “applicable nonbankruptcy law” (Id. at 757). In the wake of Patterson, several courts have seized on the phrase “in a plan or trust” to hold a broad range of retirement plans other than “trusts” excludible from the bankruptcy estate as long as the instrument contains a qualifying transfer restriction provision. For example, In re Johnson, 191 BR 75 (Bankr. MD PA 1996), a case relied on by the debtors, used this approach to find that a Sec. 403(b) annuity was not property of the bankruptcy estate. However, according to the District Court, the Third Circuit has since rejected this broader inquiry. In Orr, 104 F3d 612 (3rd Cir. 1997), it interpreted Patterson, and announced five requirements that must be satisfied before a pension plan can be excluded from the bankruptcy estate. First and foremost, it held “the IRA must constitute a ‘trust’ within the meaning of 11 U.S.C. 541(c)(2),” and, secondly, “the funds in the IRA must represent the debtor’s ‘beneficial interest’ in that trust....”

Following Orr, courts within the Third Circuit have strictly required the existence of a trust to satisfy the statutory exclusion; see, e.g., In re Williams, 290 BR 83 (Bankr. ED PA 2003) (the debtor’s IRA was not excluded because it was not a “trust” within the meaning of Section 541(c)(2)); and  Pineo, 240 BR 854 (Bankr. WD PA 1999) (concluding that IRA annuities are not excluded under Section 541(c)(2)).

In In re Adams, 302 BR 535 (6th Cir. BAP 2003), the court rejected the notion any pension plan with “an enforceable transfer restriction...designed to function in a manner ‘analogous’ to a spendthrift trust” could be excluded from the bankruptcy estate, holding instead “only an interest in a trust can be the subject of an enforceable transfer restriction within the meaning of 11 U.S.C. 541(c)(2).” The Sixth Circuit then concluded an annuity was not a “trust” within the meaning of the statutory exclusion because “[t]he purchase of an annuity ordinarily creates the relationship of debtor/creditor, not trustee/beneficiary” (Id. at 541); see also In re Wendt, 320 BR 904 (Bankr. D MN 2005) (a debtor’s interest in a Sec. 403(b) annuity was not excluded because it did not constitute a trust); In re Quinn, 299 BR 450 (Bankr. WD MI 2003) (concluding that the debtor’s interest in a Sec. 403(b) annuity was not excluded); and In re Barnes, 264 BR 415, 421 (Bankr. ED MI 2001) (discussing the “trust” requirement at length and concluding that “ 541(c)(2) applies only to trust interests”).

Thus, the District Court concluded that only a debtor’s beneficial interest in a trust may be excluded from the bankruptcy estate under Section 541(c)(2).

Gary Skiba, WD PA (8/8/2005)