On October 2, 2006, Joni Olsen's husband (let's call him "Jim") used a portion of the proceeds that he received from a motorcycle accident settlement to purchase a John Hancock deferred annuity. Jim named Joni as co-owner and co-annuitant, and their children as beneficiaries. On August 31, 2009, Joni filed for chapter 7 bankruptcy, listing her interest in the annuity at $76,860. She sought to exclude the same from her bankruptcy estate on the grounds that the money used to purchase the annuity was Jim's and not her own. Joni also had a backup argument. Even if not excluded, her interest in the annuity was nonetheless exempt under MCL 500.4054 (see below for a link to the full text of the statute).

Both arguments failed.

Joni's interest in the annuity was not excluded because Joni was not merely a co-owner but also a co-annuitant. Her co-annuitant status gave her more than nominal co-ownership rights.

Joni's interest in the annuity was not exempt because the Michigan statute does not protect the insured (Joni) from claims of the insured's (Joni's) creditors, but rather the insurer (John Hancock) from the claims of the beneficiaries' (the Olsen children's) creditors. Thus, half of the value of the annuity (the $76,860) became property of the bankruptcy estate.

The United States Bankruptcy Court for the Eastern District of Michigan, Southern Division, decided this case on March 1, 2010. In re Olsen, 424 BR. 770, 2010 Bankr. LEXIS 512 (Bankr. E.D. Mich., March 1, 2010). The U.S. District Court affirmed the Bankruptcy Court's decision on October 27, 2010. In re Olsen, 2010 U.S. Dist. LEXIS 114043 (E.D. Mich., October 27, 2010).

As a result of this case (the first to interpret MCL 500.4054 in this context since that statute became effective on January 1, 1957), advisors should not overstate the creditor protection benefits of deferred annuities in Michigan.

Link to full text of MCL 500.4054

For more information regarding this topic, please e-mail your requests to Salvatore J. LaMendola, or call Sal at (248) 457-7204.

Recently, an Arizona Federal District Court in Fry v. Northwestern Mutual Life Insurance Company, No. 3 (10-CV-08093) D. Ariz. November 4, 2010, held that Northwestern Mutual properly paid over the cash value of a life insurance policy to the IRS in order to satisfy a tax levy. In this case, the owner of a cash value life insurance policy owed taxes, penalties and interest to the IRS, which subsequently asserted a tax levy against the taxpayer's cash value in his insurance policies. In order to satisfy its tax levy, the IRS seized the loan proceeds available under the taxpayer's Northwestern Mutual policies. Northwestern Mutual did not resist the Service's efforts to seize these proceeds. The taxpayer/policy owner subsequently sued.

The District Court ruled that IRC Section 6332(e) provides immunity to any person who surrenders or pays over property in compliance with an IRS tax levy. Consequently, the District Court dismissed the taxpayer's lawsuit against Northwestern. This negative result could have been avoided, absent a fraudulent transfer, if the policy was owned by the debtor's limited partnership, limited liability company, or irrevocable life insurance trust. Generally, the best way to safeguard life insurance proceeds from creditors, while at the same time protecting the proceeds from Federal estate tax, is to transfer (or have the policy initially purchased by) an irrevocable life insurance trust. During the insured's lifetime, the cash value of an irrevocable trust-owned policy would also be outside the reach of his creditors, again, assuming a fraudulent conveyance did not occur. Furthermore, the death proceeds would also be protected from the creditors of the insured (and the trust beneficiaries) if paid to an irrevocable trust upon his/her death.

For more information regarding this topic, please e-mail your requests to Thomas P. Cavanaugh, or call Tom at (248) 457-7218.

A non-qualified deferred compensation plan must provide that benefits can only be paid upon the occurrence of one or more of the following events: separation from service, disability, death, a specified time (or pursuant to a fixed schedule), a change in ownership or effective control of the employer, or an unforeseen emergency. IRC Section 409A(a)(2). And the plan must not permit acceleration of the time or schedule of payments (e.g. haircut provisions are out), except as provided in regulations. IRC Section 409A(a)(3).

The Internal Revenue Service has issued Revenue Ruling 2010-27 to provide guidance, in the form of three examples, on what constitutes an unforeseeable emergency distribution for purposes of IRC Section 409A. The ruling concludes that an unforeseeable emergency distribution under a deferred compensation plan can be made (1) to pay for the cost of having a participant's principal residence repaired after significant water damage from a water leak in the basement; (2) to pay for funeral expenses for a participant's adult son who is not a dependent; and (3) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant or the beneficiary. However, the ruling also concludes that an unforeseeable emergency distribution does not include a distribution to pay accumulated credit card debt that is not due to events that are extraordinary and unforeseeable and beyond the control of the participant.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.