What happens during the 60 days stays in the 60 days

IRA funds withdrawn and timely rolled back into the IRA are protected in bankruptcy — no matter what the funds were used for while outside the account

May 8, 2019 @ 11:19 am

By Ed Slott

A lottery ticket retirement strategy failed to produce results.

In a desperate attempt to pay his debts and stave off bankruptcy, Richard Jones withdrew $50,000 from his IRA and spent $30,000 on lottery tickets. He lost the $30,000 and, within the 60-day rollover window (beginning on the date he received the IRA funds), deposited the remaining $20,000 back into his IRA.

As the rollover money had been returned to a qualified retirement plan when he ultimately declared bankruptcy, the U.S. Bankruptcy Court for the Southern District of Illinois ruled last month that the money remained protected from his creditors.

On or about April 16, 2018, Mr. Jones withdrew $50,000 from his IRA. He deposited $49,000 into his checking account and immediately shelled out $1,000 for lottery tickets. He was not a winner.

Over the next few weeks Mr. Jones used the money in his checking account to purchase more and more losing lottery tickets. All told, he spent $30,000.

With the 60-day rollover window closing, Mr. Jones deposited the remaining $20,000 back into his IRA on June 15, 2018, thus completing a valid partial 60-day rollover. Compounding his issues, he had incurred liabilities exceeding $9,000 for taxes and penalties resulting from the $30,000 of the money he withdrew but did not return to the IRA account.

On Oct. 22, 2018, Mr. Jones filed for bankruptcy and claimed his IRA was exempt from his creditors.

(More: 100% required minimum distributions)

The bankruptcy trustee disagreed and cited multiple cases in which retirement assets were made available to creditors. However, in each of the cases referenced by the trustee, the funds in question were either outside of the IRA at the time bankruptcy was declared or were never even in a retirement account prior to filing. The $20,000 was back in Richard Jones' IRA on the day he filed his bankruptcy case, thus distinguishing his situation from those cited by the trustee.

In addition, the bankruptcy trustee argued that the funds Mr. Jones withdrew from his IRA were commingled with other funds in his checking account. They were, but that didn't matter. The trustee contended this commingling made it impossible to determine whether the $20,000 Mr. Jones wanted protected are the exact funds that originated from the IRA. The court determined that any commingling of funds was irrelevant, and money distributed from an IRA is to be paid back "from the same amount of money and any other property."

The court cited two cases (In re Chaudury and Tax Memorandum Decision, Zaklama) in which IRA money was either used by the account owner or commingled with non-IRA assets before being replaced in an IRA via a 60-day rollover, but the courts found that no prohibited transactions occurred.

Furthermore, the court rejected the trustee's argument that whenever an account holder withdraws funds from an IRA and personally benefits from those funds during the rollover period, the entire account loses its qualified status.

(More: Should you name a trust as an IRA beneficiary?)

From the courts

The bankruptcy court cited a comment from the court decision in the Chaudury case that "what happens to the money during that 60-day period is irrelevant as long as it is repaid to the same or a different qualified account before the 60th day.

According to the Chaudury decision, "The 60-day rule would be largely superfluous if it did not permit the account owner to receive the money and use it within the 60-day period without destroying the character of the IRA's exempt nature."

"A dollar and a dream" is by no means a legitimate retirement strategy. Nevertheless, desperation has many faces. If a client does find themselves in a similar situation, proper planning is imperative.

The current level (as of April 1, 2019) for IRA federal bankruptcy protection is $1,362,800. (Company retirement plans like a 401(k) have unlimited bankruptcy protection.) However, this protection is potentially lost if all or a portion of those assets are outside of the retirement account when a bankruptcy case is filed.

Also, be aware that using rollover dollars within the 60-day rollover window for legal personal gain is neither fraud nor a prohibited transaction. Mr. Jones bought lottery tickets. In the Chaudury case, the account owner bought a house. What happens during the 60-day rollover window stays in the 60-day rollover window.

(More: 5 things clients learned about Roth conversions this tax season)

For more information on Ed Slott,Ed Slott's 2-Day IRA Workshop and Ed Slott's Elite IRA Advisor Group, please visit www.IRAhelp.com.


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