In re Rector
| Decision Date | 23 December 1991 |
| Docket Number | Bankruptcy No. HT 91-82229. |
| Citation | 134 BR 611 |
| Parties | In re Lawrene Marie RECTOR, Debtor. |
| Court | U.S. Bankruptcy Court — Western District of Michigan |
Paul I. Bare, Traverse City, Mich., for the debtor.
A. Brooks Darling, Traverse City, Mich., for Chapter 7 Trustee, James Boyd.
This matter is before me to decide whether the Debtor can exempt, under § 522(d)(10)(E) of the Bankruptcy Code, $16,159.56 held in a state established deferred compensation program. On April 22, 1991, the Debtor filed a voluntary Chapter 7 Bankruptcy Petition. According to her Statement of Affairs, the Debtor was laid off from her job as a child care worker with the State of Michigan at the Arnell Engstrom Children's Center. The State of Michigan closed the Center prior to her filing for Bankruptcy.
As a state employee, the Debtor was eligible to participate in the Michigan Department of Civil Service Deferred Compensation Program. M.S.A. § 3.256(1) M.C.L.A. § 38.1151 authorizes the Department of Civil Service to establish a deferred compensation savings program for state employees. Currently, two deferred compensation plans are available. Deferred Compensation Plan I is established under § 457 of the Internal Revenue Code. 26 U.S.C. § 457 is an accounting provision of the tax code, providing that a participant's gross income shall not include compensation set aside under an eligible plan created by a state or local government until such compensation is actually paid or otherwise made available to the participant. Deferred Compensation Plan II is established under § 401(k) of the Internal Revenue Code. In this case, the Debtor participated in Deferred Compensation Plan I.
The literature describing the deferred compensation program for state employees is divided into three sections. In the introductory portion, deferred compensation, as a savings method, is generally described. Then, each plan under the two different tax code sections is explained. In the first section of the literature, deferred compensation is defined as "a method by which you can systematically `set aside' a portion of your income into a savings program before it is taxed and thus reduce the amount of your current income taxes." The first section of the program literature goes on to specify that income set aside under either deferred compensation plan is available to the participant only upon the occurrence of four events: retirement; disability; separation (permanent—30 days or more); or death.
A more detailed discussion of withdrawal rights is contained in the two, more specific, sections of the booklet distributed to state employees. Money invested in Deferred Compensation Plan I, the alternative chosen by the Debtor, is released only upon the occurrence of one of the four events listed above or upon the showing of extreme hardship. In describing hardship withdrawal from the deferred compensation plan under § 457 of the tax code, the program literature states:
the provision for hardship withdrawal ... is utilized only in very severe emergencies of a catastrophic nature, the result of an event or circumstance beyond the control of the member where a member has suffered an identifiable financial loss (not reimbursable by insurance).
The literature goes on to make clear that:
items NOT considered hardship beyond control of the member would be the need for school tuition or to purchase a home, bill consolidation, delinquent loan, back taxes, normal auto or home repairs, automobile purchase, etc.
The alternative, § 401(k) plan, available to state employees is less restrictive in the types of withdrawals available. Some of the types of hardship withdrawals excluded from Deferred Compensation Plan I, such as school tuition and payment to prevent foreclosure of the employees principal residence, are available if the participant elected to defer income into a 401(k) plan.
In her First Amended Schedule B-4, filed on July 3, 1991, the Debtor claims an exemption under § 522(d)(10)(E) of the Code for the amount of money in her deferred compensation plan. Documents submitted by the Trustee show that the Debtor has $16,159.56 in Deferred Compensation Plan I. Having been permanently separated from service, the Debtor has obtained the withdrawal rights that accrue upon termination and now possesses the right to demand full payment of the amount in the plan. Since the Debtor now has the right to full payment, the dispute between the Debtor and the Trustee over the exemption provided by § 522(d)(10)(E) of the Bankruptcy Code concerns entire $16,159.56 held in the plan. Further, $16,159.56 is included in the Debtor's bankruptcy estate. The Debtor agrees with the Trustee and consents to the conclusion that all funds in the Debtor's deferred compensation plan are property of the estate. Therefore, provisions of the Code relating to property of the estate, such as § 541(c)(2), do not need to be discussed. I am only concerned with the issue of whether the funds are exempt.
§ 522(d)(10)(E) provides an exemption for:
a payment under a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of illness, disability, death, age or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor.
Under § 522(d)(10)(E), two conditions must be met before the Debtor is entitled to exempt funds held under her deferred compensation plan. First, Michigan Deferred Compensation Plan I must be a stock bonus, pension, profitsharing, annuity, or similar plan or contract with payment to the Debtor for the enumerated reasons. Next, any payment under the plan to which the Debtor is entitled, here, $16,159.56, must be reasonably necessary for the support of the Debtor and any dependents. See, In Re Pettit, 61 B.R. 341, 347 (Bankr. W.D.Wash.1986).
In his brief, the Trustee argues that the deferred compensation program established for Michigan employees is a savings plan that has, as its primary purpose, the reduction of income tax liability. According to the Trustee, Deferred Compensation Plan I is a tax shelter designed by the state to provide employees with a tax-exempt investment vehicle. The Trustee argues that the Debtor's plan fails to qualify under § 522(d)(10)(E) as a pension, profitsharing or similar plan or contract on account of illness, disability, death, age or length of service. To support this claim, the Trustee cites the literature given to employees which describes the deferred compensation plan as a mechanism for tax deferral and as a means to accumulate savings. The Trustee maintains that the Michigan deferred compensation program fails to restrict payment in accordance with the purpose of § 522(d)(10)(E). The Trustee concludes that since the Debtor has deferred income into an investment vehicle outside the provisions of § 522(d)(10)(E), there is no need to keep funds held within the plan away from the reach of creditors.
The Debtor responds by arguing that the state plan permits only restricted withdrawal, limited to retirement, disability, death or separation, and is the type of plan envisioned under the federal exemption of the Bankruptcy Code. The Debtor further submits that the funds invested in the Michigan plan are essential in assuring a fresh start.
The legislative history to § 522(d)(10)(E) states that "paragraph (10) exempts certain benefits that are akin to future earnings of the debtor." H.R.Rep. No. 595, 95th Cong., 1st Sess., at 361-62 (1977), U.S.Code Cong. & Admin.News 1978, pp. 5787, 6318. "The intent is to insure that such benefits are available for retirement purposes or in the event of disability or termination of employment." In Re Sheridan, 38 B.R. 52, 56 (Bankr.D.Vt.1983).
Another Vermont Bankruptcy case explains:
the test which has developed to determine whether a contract provides benefits akin to future earnings is whether account funds may be used only for the purpose of providing retirement benefits to the contract holder or to his beneficiaries in the event of his death. The test is satisfied where account funds can be diverted to no other purpose than the retirement income of the contract holder; where access to the account funds can be achieved only upon the contract holder\'s disability, death or retirement.
In Re Pauquette, 38 B.R. 170, 173-74 (Bankr.D.Vt.1984).
A brief look at the Vermont cases will illustrate the analysis that needs to occur. In the first case I cited, In Re Sheridan, the debtor was employed by the State of Vermont. The debtor sought to exempt his participation interest of $18,230 in the Vermont Employees Retirement System. Under the system's retirement plan, no benefits were payable until the debtor's employment terminated. The Court first held that future benefits under the plan were not property of the estate. The Vermont Bankruptcy Court went on to hold that, even if the benefits were part of the estate, they would be exempt under § 522(d)(10)(E). In deciding that the funds held by the system were exempt, the Court stressed the fact that payment would be made to the debtor only on account of disability, death or termination of employment. Since payment was based on a limited set of circumstances where the debtor would require the receipt of delayed earning, the Court rejected the Trustee's argument that the Vermont plan was an investment vehicle rather than a pension or retirement plan. The Court found that payment based upon termination did not remove the Vermont plan from the federal exemption. Payment upon termination was a right of the debtor akin to future earning or payment upon retirement. The Court concluded that "the debtor's right to payment under the plan falls squarely within the protection of section 522(d)(10)(E)." In Re Sheridan, 38 B.R. at 56.
In, In Re Pauquette, the dispute concerned an IRA established by the debtor. Here, the Court found that no exemption existed under...
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