Are Annuities Exempt in Bankruptcy?

Many annuities are exempt (protected) from the reach of creditors under either federal bankruptcy law or state law, but some are not. The ability to use the exemption can turn on the particular characteristics of the annuity, making this area of law complicated. If you have an annuity and you're thinking about filing a bankruptcy case, it's important that you seek out professional advice because a mistake can be costly.

What Is an Annuity?

An annuity is usually an investment account that pays the owner (also called the beneficiary or annuitant) on a regular basis, typically monthly or yearly. Annuities are designed to provide a steady income for the beneficiary, are often set up with a lump sum deposit, and are especially attractive for managing:

• insurance proceeds
• the rollover of a pension, an IRA, a 401(k), or another retirement account
• lottery winnings, or
• a structured settlement from a lawsuit.

A beneficiary can receive payments immediately, or the annuity can be set up to pay when an event occurs, such as reaching age 65. It can run for a set duration, for instance, 20 years, or it can provide payments for the life of the annuitant.

One element common to most annuities is that once created, the annuitant cannot change its terms. The terms are often relevant to the bankruptcy court when a trustee challenges the validity of an annuity's exemption (more below).

Exempting Annuities

When you file a bankruptcy case, you can protect particular types of assets with property exemptions. Every state has a list of exemptions for its residents. The federal bankruptcy code has a list of federal exemptions, as well.

In most states, the bankruptcy debtor (filer) can only use the state's exemptions, but some states allow the debtor to choose whether to apply the state or the federal exemption scheme (but mixing between the two sets isn't allowed). If you opt to use your state's exemptions, you can also use the federal nonbankruptcy exemptions.

State exemptions. State annuity exemptions vary widely. An annuity that qualifies in one state can fail to be eligible in another based on just one term, such as whether the annuity has a triggering event or whether the periodic payments exceed a given amount. A few states provide exemptions for virtually all annuities. On the other end of the spectrum, a few states don't provide any protection.

Federal retirement exemption. Regardless of whether you choose state or federal exemptions, you can exempt your annuity if it meets the Internal Revenue Code qualified retirement account requirements. You can also use a federal exemption for an annuity funded by an IRA or certain other non-qualified retirement plans, but your exemption will be capped at $1,283,025 (as of September 2017). This amount adjusts every three years with the next adjustment scheduled for 2019.

Other federal exemptions. In addition to the exemption for retirement accounts, the bankruptcy code includes an exemption for an annuity that pays "on account of illness, disability, death, age, or length of service." (Bankruptcy Code § 522(d)(10)(E).) Also, several exemptions apply to specific awards for bodily injury, wrongful death, or lost future earnings (states often have similar exemptions, too). You might be able to use one of these exemptions to protect an annuity funded by such an award; however, these exemptions cannot exceed an amount reasonably necessary to support you and your dependents.

The federal bankruptcy code also has a wildcard exemption that can be used for anything up to a value of $1,250, or $13,100.00 if you don't use the homestead exemption (figures valid as of September 2017). Many states have wildcard exemptions, as well, but most are less than the federal exemption.

Annuity Timing

The timing of the creation of the annuity can affect the exemption validity. Some states will only protect annuities purchased more than six months before the bankruptcy case filing. Even without this restriction, the Chapter 7 trustee appointed to administer your case will pay particular attention to the timing of your annuity. Converting a nonexempt asset (like cash in a deposit account) to an exempt asset (like an annuity) is not strictly prohibited by the bankruptcy code. However, when it happens shortly before filing, the court can disallow the exemption if it concludes that the debtor purchased the annuity solely to protect the funds from the reach of the bankruptcy court.

Speaking With an Attorney

Annuities are valuable assets, and, as with any other valuable property, it's prudent to talk to local bankruptcy counsel before proceeding with a bankruptcy case.