Inherited IRAs Not Exempted in Bankruptcy, U.S. Supreme Court Rules

Legal Case
Traditionally in a Chapter 7 bankruptcy, most legal or equitable interests in property is lumped into the bankruptcy estate, which is then used to satisfy creditors to whatever extent that’s possible.

However, in the interest of ensuring debtors can obtain a fresh start, they are allowed a host of exemptions, which are established by federal code and may also vary from state-to-state. Our D.C. bankruptcy attorneys know that one of these key exemptions for many people are retirement accounts – specifically IRAs (individual retirement accounts).

But there are different kinds of IRAs, and interestingly, the U.S. Supreme Court ruled recently in that inherited IRAs are not exempted because they fail to fit the traditional characteristics of a “retirement fund” as it’s generally understood.

The Clark case involved an inherited IRA, and its owner’s effort to have it exempted from the bankruptcy estate.

In 2000, a woman established a traditional IRA, and listed her daughter as the only beneficiary of that account. The original owner of that IRA died the following year, at which time the account was worth an estimated $450,000. The account was then transferred to her daughter’s ownership, thereby becoming an inherited IRA. The daughter opted to take monthly distributions from the account, which continued until the end of 2010.

At that time, the daughter (debtor) and her husband, filed for Chapter 7 bankruptcy. In that filing, they listed the inherited IRA account as exempt from the estate per 11 U.S.C. 522(b)(3)(C). By then, the account was worth about $300,000. The debtors argued these funds should be shielded from seizure by the trustee.

However, the trustee, along with a number of unsecured creditors, objected, arguing that the money in that account was not for retirement, despite the way the account was structured.

The bankruptcy court accepted this argument, and refused to allow the exemption. The debtor appealed to the District Court, which reversed on the grounds that the funds were originally accumulated for retirement purposes, and therefore should be protected. The case then went to the Seventh Circuit Court of Appeals, which reversed the District Court and reinstated the bankruptcy court’s ruling.

The case then went to the U.S. Supreme Court, which affirmed the Seventh Circuit and the original decision by the bankruptcy court. This decision also settled the issue of a conflicting ruling handed down by the Fifth Circuit Court of Appeal.

In reaching this conclusion, the U.S. Supreme Court cited three legal properties held by inherited IRAs that led the justices to conclude these accounts aren’t specifically and objectively set aside for retirement. Those properties are:

That the holder of an IRA can’t invest additional money into the account;
That the holder is required to withdraw money from the account, regardless of how many years he or she is from retirement;
That the holder may withdraw all the funds from the account at any time for any reason without incurring a penalty (versus a traditional or Roth IRA in which a person would incur a 10 percent penalty tax for such withdrawals except in rare circumstances).

Anyone with questions regarding what types of accounts would be protected in a bankruptcy filing should call our law office today for a confidential consultation.

Contact Harris S. Ammerman, bankruptcy attorney serving Washington D.C., Maryland and Virginia, by calling (202) 638-0606.

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Harris Ammerman

Since 1986, we have helped more than 10,000 clients and their families file for bankruptcy – more than any other firm in the region. We have more 50 years of combined experience and are conveniently located in the heart of Washington, D.C.
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