Are Annuities Exempt in Bankruptcy?

An annuity might be exempt (protected) from the reach of creditors under either federal bankruptcy law or state law, but many will be difficult to protect in bankruptcy. The ability to use the exemption can turn on the particular characteristics of the annuity, complicating this area of law. If you have an annuity and are considering bankruptcy, you should seek professional advice because a mistake can be costly.

What Is an Annuity?

An annuity is an investment account that pays the owner (also called the beneficiary or annuitant) regularly, 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 provide payments for the annuitant's life.

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

Are Annuities Protected From Creditors? Exempting Annuities in Bankruptcy

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 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 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 to protect a substantial amount if the annuity is funded by an IRA or certain other non-qualified retirement plans.

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 is often much larger than state exemptions. It will be available if your state allows debtors to use the federal bankruptcy exemptions instead of the state exemptions.

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, many courts frown on the practice.

Also, 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 and creditors, which is typically considered fraud.

Learn how to prove bankruptcy fraud.

Speak With a Bankruptcy Attorney

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