Written by Arizona Bankruptcy Attorney Whitney Coats
There have been split decisions in bankruptcy courts across the country on whether an inherited Individual Retirement Account (“IRA”), a retirement account inherited by someone other than a surviving spouse, is protected from an individual’s creditors when filing bankruptcy. The Supreme Court has put its’ final say on the issue and determined that inherited IRAs will not be protected under Federal law if an individual files bankruptcy and therefore can be reached by creditors.
In Clark v. Rameker, Trustee, Petitioner Heffron-Clark, inherited an IRA worth about $300,000 in 2001 from her deceased mother. Heffron-Clark and her husband filed for Chapter 7 bankruptcy in 2010. They sought to exclude the inherited IRA funds from the bankruptcy estate using the “retirement funds” exemption under Section 522 of the Bankruptcy Code, which exempts tax-exempt retirement funds from a bankruptcy estate.
In a unanimous decision written by Justice Sotomayor, the Supreme Court opined that “‘retirement funds’ is … properly understood to mean sums of money set aside for the day an individual stops working.” The point of exempting retirement funds from bankruptcy, wrote Sotomayor, is to ensure that those who declare bankruptcy can still “meet their basic needs during their retirement years.” Indeed, an original IRA account holder may not withdraw funds before age 59 without paying a steep penalty. In contrast, an inherited IRA is treated in exactly the opposite way, with withdrawals mandated annually. The possibility that some investors may use their inherited IRAs for retirement purposes does not mean that inherited IRAs bear the defining legal characteristics of retirement funds. Were it any other way, money in an ordinary checking account (or, for that matter, an envelope of $20 bills) would also amount to ‘retirement funds,’ because it is possible for an owner to use those funds for retirement.”
This decision significantly affects anyone considering filing bankruptcy who owns an inherited IRA received from a deceased parent or relative and may certainly be a determining factor on whether bankruptcy is a viable option to pursue at all.
Whitney G. Coats, J.D., Of Counsel, is a bankruptcy attorney who works with Dana Law Firm’s Consumer Bankruptcy Department.