By Ryan C. Wood
Individual Retirement Accounts (“IRA”) are generally exempt up to $1,245,475 from the bankruptcy estate when someone files for bankruptcy. This means you can have $1 million sitting in your IRA and still be able to file for bankruptcy protection without having to use your IRA funds to pay back your creditors. Do the same exemptions apply to someone that inherits the IRA from someone they are not married to (example: parents or grandparents)? The Supreme Court answered this question with a big fat “No” in a recent case.
In Clark v. Rameker, 573 U.S. ______ (2014), Heidi Heffron-Clark inherited an IRA from her mother, Ruth Heffron worth about $450,000 in 2001. Ms. Heffron-Clark received monthly distributions from this account. Ms. Heffron-Clark and her husband Brandon Clark filed for Chapter 7 bankruptcy protection in October 2010. At that time there was about $300,000 left of the inherited IRA which the Clarks tried to protect claiming the funds were exempt under 11 U.S.C. §522(b)(3)(C). The trustee in the case objected to the use of the exemption because the funds in the inherited IRA were not considered “retirement funds” within the meaning of §522(b)(3)(C).
The Supreme Court agreed with the Chapter 7 trustee. The Supreme Court held that inherited IRAs had three characteristics that led them to the decision that inherited IRAs are not set aside for the purpose of retirement. First, the new owner of the inherited IRA cannot contribute their own money into the account. This is one of the biggest differences between an inherited IRA and a traditional or Roth IRA. The purpose of these IRAs are to contribute your own money to the retirement account and to receive tax incentives for doing so. Secondly, owners of the inherited IRA are required to withdraw the funds from the account without taking into account how far away they are from retirement age. This of course leads to a decrease in funds over time and this is different than what a regular retirement account is trying to achieve. Finally, the owner of the inherited IRA can withdraw the entire amount of the funds at any time without having to pay a penalty regardless of their age. With a traditional or Roth IRA, the opposite is the case. If you withdraw funds from the account before reaching the retirement age of at least 59½ you are penalized.
With those three characteristics in mind, the Supreme Court held that there is nothing that stops someone from using the entire balance of the inherited IRA to buy luxurious items like vacation homes or fancy sports cars after the bankruptcy case is completed. This is not what the Bankruptcy Code intended. The bankruptcy process is to help honest people who are in need of help to obtain a fresh start in life. It is not for people to take advantage of the system to get rid of their debts while keeping all of their assets to the detriment of creditors.
The Court rejected the Clarks’ argument that the inherited IRAs are deemed to be retirement funds because they were initially set aside for retirement. The Court said if this argument was true, then following the same logic, anyone withdrawing funds from their traditional IRA account to give to a friend or family member who then deposits the money in their own bank account would consider the money in the bank account protected because it is retirement funds since it was originally set aside for retirement. That is obviously incorrect.
The Clarks’ bankruptcy attorney made some other arguments which the Supreme Court shot down. The Supreme Court concluded that inherited IRAs were not considered retirement funds if it is inherited by anyone other than the spouse of the deceased owner of the IRA account. That is because the spouse of a deceased owner of the IRA account can roll the IRA into his or her own retirement account. This rollover is not available to anyone besides a spouse.
If you received an inherited IRA and are considering filing for bankruptcy it is highly advisable that you speak with an experienced bankruptcy lawyer before filing. You should also notify your attorney to the fact that the IRA is inherited. Attempting to file the case yourself without any professional legal help may be detrimental and may lead to you losing your valuable assets.