Physicians, like anyone else, commonly get personal and business loans. As part of getting a loan, a promissory note and security agreement are usually included and signed with little review or thought. Unfortunately, in signing these documents, it’s possible for your IRA assets to be inadvertently pledged as part of the transaction.
The ruling in the Florida case, Kearney Construction Company, LLC v. Travelers Casualty and Surety Company of America, held that a debtor’s personal IRA, which is normally protected from creditors, was no longer protected because it was pledged when the IRA owner signed a blanket security agreement granting the lender a security interest in all the debtor’s accounts. Mr. Kearney had executed a promissory note and signed the blanket statement before filing for bankruptcy.
The UCC-1, a standard security agreement lenders file to record their security interest in assets, had generic blanket collateral language and granted the lender a security interest in “all assets and rights of the pledgor.” Because of this, the court says it was enough to grant a valid security interest in an IRA.
Since giving a security interest in an IRA is considered a prohibited transaction for tax purposes, the result is disastrous on two fronts. One, a pledged IRA is deemed immediately terminated, and a taxable distribution occurs; and two, the IRA loses its tax-exempt status and is no longer qualified as a creditor-exempt asset under Florida law.
While many believe this case was wrongfully decided and the Florida legislature is actively trying to fix it, we need to be aware of this decision in planning any current and future financing transactions. A few simple moves and awareness can prevent you from being in a bad situation like Mr. Kearney.
To avoid this situation, any pledge agreement signed going forward should be clear that retirement accounts and other creditor-protected assets are not pledged. The next question becomes, where does this leave debtors who executed blanket pledges in the past?
This now leaves physicians in Florida and perhaps other states who have signed these blanket pledge statements (which includes anyone who has a mortgage, credit card, or other loans) in a state of flux, questioning if their IRAs have lost their tax-exempt status and are no longer creditor protected.
So, what can be done to correct the past? Here are a few untested suggestions:
- Renegotiate the security agreement with the lender to provide clarity. This should be done with great care.
- Refinance the debt and negotiate a new security pledge agreement to provide clarity on the IRA and other creditor-protected assets.
- Rollover your existing IRA to an ERISA-Sponsored Plan (i.e., 401(K))
- Set up a new IRA and roll over the existing IRA. It is unclear how the new IRA is treated from a creditor protection standpoint since funded with a possibly tainted IRA.
- Use your IRA to purchase creditor-protected assets.
- Do a Roth conversion.
- Do a lifestyle withdrawal from your IRA. This will allow you to place new earned income into other creditor-protected vehicles.
Before implementing any strategy, please consult an attorney or tax advisor. While we wait to see if legislation fixes the issue, any security agreement should be closely reviewed by legal counsel and provide for language to exclude any tax-advantaged assets. Going forward, pledging assets should be done with great care. If not, you may end up losing your IRA and incurring a large tax bill.
Rx Wealth Advisors is a physician-focused financial advisory firm. Their primary focus is to help medical doctors maximize their earnings, keep more money in their pocket, and cultivate wealth so they can live the life they’ve earned and deserve. Rx Wealth can be reached at 412-227-9007, via email at croe@rxwealthadvisors.com, or on the web at rxwealthadvisors.com.
The situations or opinions mentioned in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments or strategies may be appropriate for you, consult your financial advisor prior to investing.