IRA Bankruptcy Ruling

In a decision that is likely to impact future estate planning considerations with respect to retirement plan assets, the Supreme Court (the Court) decided, in a 9-0 ruling, that inherited individual retirement accounts (IRAs) are not exempt from federal bankruptcy protection (Clark et ux. v. Rameker, Trustee, et al., No. 13-299). The Court held that inherited IRAs do not qualify as “retirement funds” within Section 522(b)(3)(C) of the federal Bankruptcy Code.

The Bankruptcy Abuse Protection Act of 2005 provides bankruptcy protection for assets held in IRAs. When an individual files for bankruptcy, retirement funds are one of the asset categories that can be exempt from the bankruptcy estate. In 2010, an individual and her spouse filed for federal bankruptcy protection, listing an inherited IRA worth roughly $300,000 as exempt from the bankruptcy estate. The bankruptcy trustee and unsecured creditors objected, claiming the inherited IRA was not considered “retirement funds” under the existing Code. The Bankruptcy Court agreed and disallowed the exemption. A District Court reversed, finding that the exemption covers any account that contained funds originally intended for retirement purposes.

The Court held there are three legal characteristics of inherited IRAs that provide evidence that they are not retirement funds. Individuals who have inherited IRAs:

1. May never invest additional money into the account.
2. Are required to receive distributions from these accounts regardless of their proximity to retirement.
3. May withdraw the entire account balance at any time and use the proceeds for any purpose without being subject to the 10% early withdrawal penalty.

A spouse beneficiary also has the option of rolling the deceased participant’s funds to his or her own traditional IRA, which would then be exempt from bankruptcy.