Under the Bankruptcy Code, money held in a retirement account is generally exempted from the bankruptcy estate if the retirement account is exempt from taxation under specified provisions of the Internal Revenue Code. In other words, those funds are not available to creditors to pay off debts.
In June 2014, the United States Supreme Court decided the question of whether an inherited individual retirement account-not from one spouse to the surviving spouse-was within the Bankruptcy Code’s exemption.
Clark v. Rameker
In Clark, the wife inherited an IRA from her mother in 2001 valued initially at $450,000; she decided to receive monthly payments from the IRA instead of a lump sum. In 2010, the wife and her husband filed a Chapter 7 bankruptcy petition; the IRA, valued then at $300,000, was identified as an asset but claimed as exempt. The bankruptcy trustee and the creditors disagreed, asserting that the inherited IRA was not retirement funds within the meaning of the Bankruptcy Code. The Supreme Court took the issue, since there was a disagreement between two Circuits on the issue.
What does “retirement funds” mean?
Since the term is not defined by the Bankruptcy Code, the Court gave “retirement funds” its ordinary meaning-funds set aside for when one stops working. However, the term is defined in the context of the IRC.
Differences between “regular” and inherited IRAs
As analyzed by the Court, the first difference noted by the Court between a “regular” IRA and an inherited IRA is that the IRC encourages regular, systematic contributions into both IRAs and Roth IRAs while contributions cannot be made into inherited IRAs. Second, holders of inherited IRAs must begin taking withdrawals from the IRAs no matter their ages, while there are strict limitations on withdrawals from IRAs and Roth IRAs. Third, the holder may withdraw the entire amount of the inherited IRA upon inheritance without penalty, in contrast with a traditional or Roth IRA where withdrawal before age 59½ results in a ten percent penalty.
Thus, an inherited IRA represents money for immediate consumption, not money set aside for retirement.
Accordance with Bankruptcy Code’s purpose
The purpose of the Bankruptcy Code is to enable a fresh start for the debtor; the exemptions are to enable the debtors to have essential needs to start over. The retirement funds exemption protects those funds that the debtors have saved to protect them during their retirement years. To exempt an inherited IRA would potentially allow such debtors a “free pass” and potentially lead to abuse.
If you find yourself in financial difficulties and you are wondering if bankruptcy is an option, you should contact an attorney experienced in debt relief and bankruptcy to see what options you may have.