By Eric Fischer, a law clerk in Nyemaster Goode's summer program
When individuals file for bankruptcy protection, certain “retirement funds” are exempt from the bankruptcy estate under 11 U.S.C. Section 522(b)(3)(C). The exemption means the funds will not be paid to creditors, and will remain the funds of the individual after the bankruptcy proceeding. In its recent opinion in Clark v. Rameker, the U.S. Supreme Court, noting that “‘[t]he historical purpose’ of . . . [this exemption was] to provide a debtor ‘with the basic necessities of life’ so that she ‘will not be left . . . a public charge[,]’” decided that funds in an inherited IRA do not qualify as retirement funds within the meaning of the bankruptcy exemption. Accordingly, inherited IRA funds are available to pay creditors of a bankruptcy estate.
The Court held that an inherited IRA, being “a traditional or Roth IRA that has been inherited after its [original] owner’s death[,]” clearly does not fall within the definition of retirement funds for three reasons: first, “the holder of an inherited IRA may never invest additional money into the account”; second, the holder of an inherited IRA is required to withdraw the funds, even if not yet retired; and finally, the holder of an inherited IRA can withdraw the funds at any time without penalty. The Court also noted that allowing an inherited IRA to be exempt from bankruptcy would provide for the possibility of a cash windfall following a bankruptcy which would frustrate the original purpose of the exemption.
Traditional or Roth IRAs that a spouse inherits and then rolls over into his or her own individual retirement account, as allowed by law, are unaffected by this ruling. Thus, this ruling provides another reason for a spousal beneficiary of an IRA to transfer the funds into his or her own IRA, rather than keeping the funds in an inherited IRA. The tax code and IRS regulations allow for such a transfer for spousal beneficiaries, but not for non-spousal beneficiaries.
The opinion is here.