Bankruptcy protection for IRAs and retirement plans: tracing rollovers now gains paramount importance.

The new bankruptcy act entitled the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005" was enacted on April 20, 2005. Let's call the new law BAPCPA, for short.

Although traditional IRAs and Roth IRAs are granted limited protection under BAPCPA (generally not to exceed $1,000,000), qualified plans and certain other retirement arrangements such as 403(b) arrangements and 457 plans are granted unlimited protection under the act.

Further rollovers into IRAs from qualified plans and certain other retirement arrangements as discussed above are also granted unlimited protection. The earnings on these rollovers are also protected in bankruptcy. Tracing of these rollovers is now paramount.

If the qualified plan has a favorable IRS determination letter that is in effect as of the date of the filing of the bankruptcy petition, then under BAPCPA those funds are presumed to be exempt from the estate of the debtor.

However, many small employers use prototype plans that are sponsored by such organizations as banks, brokerage firms, mutual funds, insurance companies and other organizations. These plans do not have IRS favorable determination letters but instead have IRS opinion letters.

If the retirement funds are in a retirement plan that has not received an IRS favorable determination letter, then according to the BAPCPA those funds are protected in bankruptcy if the debtor can demonstrate that:

* No prior determination to the contrary has been made by a court or the Internal Revenue Service

* The retirement fund is in substantial compliance with the Internal Revenue Code 

* The retirement fund fails to be in substantial compliance with the Internal Revenue Code and the debtor is not materially responsible for that failure

But small employers who use prototype documents often fail to administer their qualified plans properly. Many times they do not timely adopt amendments to the plan that are necessary in order to maintain the tax qualification of the plan.

If a prototype plan is not tax qualified, then significant tax sanctions are generally applicable and may be imposed by the IRS against the employer, the plan's trust and the plan participants.

If the prototype plan is not timely amended by the employer, then the plan is not a tax qualified plan. According to BAPCPA, if the debtor was materially responsible for that failure, then his/her interest in the plan would not be protected in a bankruptcy situation.

Seymour Goldberg, CPA, MBA, J.D. is a senior partner in the law firm of Goldberg & Goldberg, P.C., Melville, NY. He is the author of "Retirement Distribution Practice Aids," a collection of forms and letters published by the AICPA that practitioners can download and use to advise their clients of their rights, choices and obligations in the retirement distributions area.

Seymour Goldberg, CPA, MBA, J.D.

Author of Retirement Distribution Practice Aids