IRA Settling Lawsuit

[Guest Wobble14]

A client is being sued personally. His self-directed IRA is also a named defendant in the lawsuit. The parties have worked out a settlement and the IRA will pay a portion of the amount necessary to settle the lawsuit. Is this a prohibited transaction under 4975? I think it is, but can't find any affirmative authority. Also, the settlement is not subject to the exemption granted under PTE 2003-39 because that does not apply to claims brought against a plan. Any help would be greatly appreciated!!!

[QDROphile]

It will be very difficult to show that amounts paid by the IRA in settlement did not benefit the IRA owner in the owner's personal capacity. If the IRA paid less in the settlement, the owner would probably have to pay more.

[jpod]

What did the IRA do that could make it a defendant in a lawsuit? You need to give us more facts.

Putting the facts aside, a couple of thoughts. First, if the client is going to pay some of the settlement with IRA dollars, because of risks like those described by QDRO, transfer the dollars to a separate IRA first, and then have the transferee IRA make the payment (if you can find a transferee trustee or custodian to go along with these shenanigans). That way, if this blows up only the dollars moved to the transferee IRA will be taxed, not the entire IRA.

Second, assuming the client is going to pay some of the settlement with IRA dollars, what as a practical matter is accomplished if the IRA custodian is going to report it on a 1099-R as a distribution? The answer is "nothing." So, this is pie in the sky and a waste of brain power unless you know that the custodian will not report it as a distribution.

Third, is the individual age 59-1/2? If so, is it worth it to him to risk the additional 10% tax on top of the regular income tax, rather than pay the entire settlement out of his own non-IRA resources?

[My 2 cents]

Just guessing here. Not a practitioner in the IRA arena.

I agree with a previous poster - what possible justification could there be for the IRA being named as a defendant in a lawsuit? Is there an allegation of fraudulent conveyance (stashing the money there before the court could require the individual pay it)?

The IRA, as I understand it, could not be reached otherwise in the event that the individual loses the suit and declares bankruptcy unless the funding of that IRA itself was ruled as an attempt to defraud creditors. Would it be necessary to name the IRA as a defendant in order to assert that the individual had bad motives in putting the money there in the first place and requiring that the money be removed from the IRA?

Withdrawing funds from an IRA, to my mind, would never be a prohibited transaction. Taxable, yes, and perhaps subject to the pre-59 1/2 excise tax, but at all times, IRA holders can make withdrawals if they are willing to accept those consequences. I could be wrong. The motivation for the individual taking money out (presumably for purposes intended to benefit that participant in some way) could not matter. IRA's don't have hardship withdrawals, do they? Taxes and penalties yes, but other restrictions no.

[QDROphile]

Withdrawing amounts from an IRA to pay a settlement on behalf of the IRA (or paying a settlement of the owner's liability) and having the IRA pay a settlement are two different matters. Withdrawal from an IRA does not raise prohibited transaction concerns.

While I am curious about how the IRA ends up as a defendant, it is possible. And that would be a different question from whether or not an IRA can be reached to satisfy an obligation of the IRA owner.