Annuities are Exempt from Creditors – In Wisconsin

The Seventh Circuit Court of Appeals has sustained a Bankruptcy Court decision holding that annuities qualifying for income tax deferral under Section 72 of the Internal Revenue Code (“IRC”) are exempt assets and therefore cannot be executed upon by the debtor’s judgment creditors.

In Wittman v. Koenig (July 26, 2016), the debtors sought to exempt three annuities with a value of $292,185.97. The Bankruptcy Court decided that the annuities are exempt assets. The parties, along with the Seventh Circuit, agreed that it was appropriate to invoke a procedure permitting a direct appeal to the Seventh Circuit to rule on this legal issue thereby bypassing the district court. This is a significant victory for debtors who are residents of Wisconsin. Despite their bankruptcy, this husband and wife can retain ownership of the annuities while at the same time discharging their debts. Why would this be permitted and do Michigan residents have the same opportunity.

Wisconsin is one of those states whose residents may choose either the Federal exemptions or its state exemptions. Wisconsin’s bankruptcy exemption statute exempts annuities and, not surprisingly, the debtors in this case elected to use the state exemptions. An annuity is defined broadly in the Wisconsin statute as “a series of payments payable during the life of the annuitant or during a specific period.” There are several sections of the Wisconsin statute dealing with annuities; the first covers retirement assets, including annuities. The second is a broader category of annuities that do not meet the definition of the first section. However, the broader category imposes dollar limits on the amount of annuities exempted. The exemption is limited to $150,000 except that the cap is just $4,000 for annuities issued less than 24 months before the creditor claims the exemption. In this case the debtor had purchased the annuities 18 months before they filed their petition. So the determination of what section applied was critical for maximizing the debtors’ exempt assets.

It came down to the exercise of good old statutory language interpretation. The trustee argued that only the second section applied because otherwise the annuity must comply with the provisions of Sections 401-409 of the IRC (which admittedly it did not). But the Seventh Circuit disagreed. It concluded that the annuities need only comply with provisions of the IRC including Section 72 . . . which it did comply with. There was nothing in the statute or its legislative history that compelled a conclusion that the unlimited exemption for annuities only applied to annuities that complied with Sections 401-409 of the IRC. Furthermore, the Wisconsin statute chose to require a liberal construction of the exemption statute. The following language was persuasive: “This section shall be construed to secure its full benefit to debtors and to advance the humane purpose of preserving to debtors and their dependents the means of obtaining a livelihood, the enjoyment of property necessary to sustain life and the opportunity to avoid becoming public charges.” So where a call had to be made between two possible interpretations, both reasonable and justifiable, it is clear that the Wisconsin legislature intended the call to be made in favor of the debtor.  And with this decision there was born a very viable asset protection strategy for Wisconsin residents—buy tax deferred annuities (while tax deferred annuities were previously held to be exempt assets, the decision of the Seventh Circuit removed any doubts about the interpretation of the Wisconsin statute).

Unfortunately, Michigan residents do not have the same opportunity. Michigan is also a state which allows debtors in bankruptcy to choose between the Federal exemptions and the state exemptions. MCLA 600.5451(k) exempts individual retirement annuities as defined in IRC Section 408 or IRC Section 408a and the distributions from these annuities. Subpart (l) further provides that an annuity contract under Section 403(b) of the IRC is exempt if it is subject to ERISA. Thus the annuity in the Wittman case, which only complied with Section 72 of the IRC, would not have been exempt if the debtors were Michigan residents electing the Michigan exemptions.

Both federal bankruptcy law and state law contain fraudulent transfer restrictions. Accordingly, even a Wisconsin resident cannot run out and purchase annuities with the intent to hinder, delay or defraud his creditors. But Wisconsin residents may engage in prophylactic planning at the appropriate time and have a high degree of comfort that annuities will be exempt from the claims in bankruptcy.