Originally published on Forbes.com.
The Individual Retirement Account (IRA) is a great tax vehicle allowing an immediate deduction and tax-deferred growth or (in its deferred-gratification Roth form) tax-free growth. But that’s not all. The IRA can also be an asset protection vehicle – bankruptcy remote. The details vary from state to state as is shown in this chart (it may need updating). So the Eleventh Circuit decision Yerian v Webber, which confirmed a judgment that Keith Yerian’s self-directed IRA could go to his creditors is a big deal.
Bad Facts
Taking the findings in the decision at their face value, Keith Yerian’s behavior was on the egregious side.
Keith Yerian made some interesting choices with respect to the management of his individual retirement account. These choices included titling IRA-owned cars in his own name and his wife’s name, as well as purchasing a condo in Puerto Rico with IRA funds and then using the condo for his personal travel needs. Yerian concedes that he incurred over one hundred thousand dollars in tax penalties for abusing his IRA.
You have to really wonder what is going on at IRA Services Trust Company, the custodian of the IRA. From their website, it appears they give you advice to avoid prohibited transactions and caution you that there are bad consequences if you do them, but based on the facts, in this case, they are not looking over your shoulder and checking up on you.
Significant Decision
I spoke with Kevin Robinson of Zimmerman, Kaiser & Sutcliffe, who represented the trustee Richard Webber to clarify how the case developed. He gave me some Bankruptcy 101 instruction along the way. The trustee is a fiduciary who is supposed to gather up as many assets as possible for the creditors. Among other things, the trustee can challenge a claim of exemption of a particular asset by the debtor.
So the debtor claimed that the assets inside the self-directed IRA were exempt. The basis for the trustee’s challenge was that the assets were not managed in accordance with the IRA’s governing document, which required that there not be “prohibited transactions”.
Nobody is arguing whether there were prohibited transactions. The question which you can hear about in the oral arguments if you have half an hour to spare is whether the trustee and the bankruptcy court should be poking into that. Sure, if the IRS comes in and blows up the plan it is not an exempt asset anymore but until then it should still have that status would be the other side of the argument.
The Eleventh Circuit sees it otherwise.
Yerian failed to maintain his IRA in accordance with its governing instruments, which explicitly prohibited the acts of self-dealing he engaged in with his IRA funds. As a consequence, he is not entitled to claim a creditor exemption for his IRA under section 222.21(2)(a)(2). The judgment of the district court is AFFIRMED.’
Kevin Robinson told me that it is a case of first impression, so it may serve as a wake-up call to bankruptcy trustees to poke and prod self-directed IRAs to challenge their exemption. He also sees this as a closing of a loophole.
The Trustee is very pleased with the result reached by the Eleventh Circuit Court of Appeals, which will prevent bad actors from gaming the system to claim assets as creditor-exempt in bankruptcy by placing them in a self-directed IRA but then using those same assets for their personal benefit.
Who Is In Charge Here?
The facts, in this case, were pretty egregious. Will bankruptcy trustees start scrutinizing plan operations closely in order to find some foot fault that would disqualify them? Self-directed IRAs have always made me a little nervous and I find it a little shocking that the transactions described in this decision would not have set off alarm bells at the custodian. I’m thinking there might be a bigger story there.
The practical takeaway I get from the decision is that if you have reason to be concerned about asset protection, you might want to think about whether a self-directed IRA is your best choice since apparently, it is not just the IRS you have to worry about looking over your shoulder.
Other Coverage
Kamryn M. Deegan had Florida Exemption Does Not Shield Improperly Maintained IRA From Creditors on 11thCircuitBusinessBlog.com.