Are Annuities Sheltered From Creditors?

Federal bankruptcy laws and state law provisions typically define whether an annuity offers creditor protection.

Jan 18, 2016 at 7:03PM

Many investors never think about protecting their assets. Yet for many in high-risk professions, asset protection from current and potential creditors is a major concern in their financial planning. Annuities can offer creditor protection, but you have to look closely at the laws of your own state to see whether they cover annuities and the extent to which annuity assets are sheltered from creditors.

Federal bankruptcy exemptions and annuities
Bankruptcy law is federal, and exemptions apply for certain assets related to annuity contracts and life insurance policies. Section 522(d)(8) of the Bankruptcy Code establishes an exemption for "any unmatured life insurance contract," and the inflation-indexed maximum amount protected is $12,250 in cash value.

Section 522(d)(10)(E) further extends exemptions to payments under annuities payable by reason of illness, disability, death, age, or length of service to the extent reasonably necessary for the debtor's support. These exemptions are relatively limited, however, and so few annuity owners rely on them for creditor protection.

Where federal exemptions play a bigger role is in annuities held in retirement accounts. Creditor protection for IRAs and for retirement plans covered under federal ERISA law is much more extensive, and so if you choose to have an annuity within a retirement plan, it typically provides much more protection from creditors.

State law
State law also defines creditors' ability to collect against annuity assets, and there, the provisions are much more varied. In some states, annuities are treated as being similar to IRAs and other retirement accounts, with the result being almost complete creditor protection. You'll often find additional provisions that provide exceptions to this general rule that apply in cases of potential abuse, such as buying an annuity immediately before declaring bankruptcy or becoming insolvent.

Most other states provide limited protection for annuities in a way that's similar to federal bankruptcy law, using the same reasonably necessary standard. Each state will apply that standard differently, but the net result is that only a portion of annuity assets will be protected, allowing creditors to make claims for the remainder.

There are two key lessons for those looking to use annuities for creditor protection. First, make sure you understand your state's laws before you make a decision to buy the annuity. Second, if you decide to use annuities for creditor protection, don't wait until financial trouble hits. The sooner you take action, the less likely it will be that a court will strike down your purchase as being intended to defraud creditors.

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