In the retirement plan context, many physicians and their advisors devote considerable efforts to investment strategies, tax planning and estate planning. However, building a physician’s nest egg may ultimately be for naught if unanticipated creditors are able to attach retirement plan assets. Creditors may become a factor if, for example, a patient secures a judgment against a physician which is not covered by the physician’s malpractice insurance (or is in excess of policy limits), or if outside business ventures result in unexpected liabilities. Therefore, protection from creditors is a critical component of the retirement planning process.

Of course, most physicians would consider personal bankruptcy only as a last resort. However, since legal battles between debtors and creditors are often played out in bankruptcy, much of the law in the area of asset protection arises in the context of bankruptcy proceedings, and this final resort sometimes becomes necessary for wealthy individuals as well as those with lower income levels. Therefore, an understanding of basic bankruptcy principles is helpful.

When an individual files for personal bankruptcy, property owned by the individual generally becomes part of the individual’s bankruptcy estate. However, certain property is either (a) excluded from the bankruptcy estate altogether, or (b) "exempt" from attachment under federal and state law. In either case (exclusion or exemption), the property remains outside of the reach of creditors. This determination is complicated by the fact that, under the terms of the federal Bankruptcy Code, individuals may exempt either (a) types of property included on a federal exemption list, or (b) types of property exempt under non-bankruptcy federal law or state or local law. The federal Code also permits individual states to limit bankrupt debtors to the second option, and most states have in fact "opted-out" of the federal exemption scheme. Therefore, different results can be achieved depending on the state in which the debtor resides.

Traditionally, the treatment of retirement plans in bankruptcy has also largely depended on the type of plan involved. Assets in employer-sponsored, tax-qualified retirement plans (e.g., pension, profit sharing and 401(k) plans) have generally been protected from the reach of creditors since the decision of the U.S. Supreme Court in Patterson v. Shumate (1992). More specifically, the Court determined that such assets are excluded from the property of the bankruptcy estate, based on the "anti-alienation" provisions required to be included in such plans under the Employee Retirement Income Security Act of 1974 (ERISA).

Narrow exceptions from the rule of Patterson v. Shumate have been applied in cases where a plan covers only a business owner and his or her spouse, on the theory that such plans do not cover "employees" and therefore are not subject to ERISA. Therefore, physicians with no employees who are participants in their plans are more vulnerable. However, the 2004 decision of the Supreme Court in Yates v. Hendon (1994) made clear that, as long as one or more non-owner employees are participants in a plan, the ERISA protection extends to the owners as well as the non-owner employees.

In contrast with qualified employer plans, IRAs are not covered by ERISA or the Patterson v. Shumate decision. Therefore, the extent to which IRAs have been protected has generally been a function of state law, which obviously varies from jurisdiction to jurisdiction. Although most states have statutes protecting IRAs to some degree, many of those statutes contain limitations such as a fixed dollar amount or an amount determined to be necessary for the support of the individual debtor. Pennsylvania’s statute, for example, does not protect contributions to an IRA in excess of $15,000 per year. Importantly, the Pennsylvania statute was amended in 1998 to provide that rollovers from qualified employer plans do not constitute "contributions" for purposes of the $15,000 limit. In any event, an individual who relocated from one state to another always faced the possibility that he or she was subjecting IRA assets to a lesser degree of protection under a different state law.

On April 4, 2005, the U.S. Supreme Court extended the level of protection available to IRAs under federal bankruptcy law in the case of Rousey v. Jacoway (2005). Unfortunately, the effect of this decision was overstated by many newspapers and financial journals. In fact, the Supreme Court decided only that IRAs are of the type of plans protected under a particular provision in federal bankruptcy law. In order to take advantage of that provision, a debtor still had to demonstrate that the assets were "reasonably necessary for the support of the debtor and any dependent of the debtor." This "support standard" has generally been interpreted to mean basic subsistence, as opposed to the standard of living to which the debtor has been accustomed. Ultimately, therefore, the Rousey case did little to protect the IRAs of more wealthy individuals.

The timing of the Rousey decision was ironic since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA) was signed into law by President Bush just a few weeks later, on April 20, 2005. The general purpose of BAPCA was to tighten the rules for personal bankruptcies (measures long sought by the banking and credit card industries), but the new law also made significant changes in the area of retirement plans. BAPCA is generally effective for bankruptcies filed on or after October 14, 2005.

Under BAPCA, all retirement funds exempt from taxation under Sections 401, 403, 408, 408A, 414, 457 and 501 of the federal tax code are now protected from the reach of creditors. Since IRAs are covered by Section 408 of the tax code, we finally have uniform treatment of IRAs and qualified plans in bankruptcy, with one exception (noted below). Most importantly, the protection of IRAs under BAPCA applies without regard to the state in which the debtor resides, and without regard to the extent to which the IRA assets are necessary for the support of the debtor and his or her family.

Under the exception, the amount of the protected IRA assets is limited to $1 million. However, this limit is applied without regard to any rollover contributions from qualified plans. Therefore, under BAPCA, an individual can roll assets from a qualified employer plan into an IRA with the comfort that 100 percent of the rollover amount (and investment earnings thereon) is protectible in bankruptcy, without regard to the state or states in which they reside currently or at any point in the future.

Outside of bankruptcy, the laws in effect prior to BAPCA continue to apply. Specifically, most qualified employer plans are protected under ERISA, but the status of IRAs and non-ERISA qualified plans will continue to depend on state law. In a case where state law does not protect retirement plan assets outside of bankruptcy, the debtor may be forced to file for bankruptcy in order to enjoy the protection now offered by BAPCA. Although bankruptcy is never an attractive alternative, physicians can take some comfort in the fact that BAPCA is available if necessary to protect their rollover IRAs.