The Trend Continues:
 
More Courts Protect Inherited IRAs in Bankruptcy
 
Submitted by Abigail C. Waeyaert
 As published in the Califf & Harper, P.C. August 2012 Newsletter
 
 
 
The law continues to develop in the inherited IRA arena as more courts across the country find inherited IRAs are exempt in bankruptcy.
 
An inherited IRA is an IRA that is inherited by a non-spouse beneficiary (i.e. you inherit your mother's IRA upon her death). Certain property is exempt in bankruptcy, including IRAs in some states, meaning creditors' claims cannot be paid from that property. Courts across the country that have addressed the issue of whether or not inherited IRAs are exempt in bankruptcy have come to differing conclusions, with some finding inherited IRAs are exempt and others finding inherited IRAs are not exempt.
 
As noted in our previous article "Protection of Inherited IRAs in Bankruptcy," seen in the Califf & Harper, P.C. December 2011 Newsletter, the trend has been for courts to allow the exemption for inherited IRAs. This trend has continued with the courts who have addressed this issue in 2012, with more courts in jurisdictions facing the issue for the first time determining inherited IRAs are exempt and previous lower court rulings finding that inherited IRAs are not exempt in bankruptcy being overturned on appeal.
 
Four recent court decisions have found inherited IRAs are exempt from bankruptcy, determining an inherited IRA meets the two part test of being (1) "retirement funds," and (2) exempt from taxation under one of the applicable sections of the Internal Revenue Code:
 
  • January 2012 - United States District Court in Wisconsin
  • February 2012 - United States Bankruptcy Appellate Panel for the Ninth Circuit (the Ninth Circuit is the federal circuit which has jurisdiction over Alaska, Arizona, California, Guam, Hawaii, Idaho, Montana, Nevada, Oregon, Washington and the Northern Mariana Islands)
  • March 2012 - United States Court of Appeals for the Fifth Circuit (the Fifth Circuit is the federal circuit which has jurisdiction over Louisiana, Mississippi and Texas)
  • May 2012 - United States Bankruptcy Court for the District of Massachusetts
 
To date, no new cases in either Illinois or Iowa have been decided on this issue, and thus individuals in Illinois and Iowa continue to face uncertainty as to whether an inherited IRA will be exempt (as noted in the December 2011 article, a case from the state of Illinois determined inherited IRAs are not exempt in bankruptcy, but that court solely examined exemptions pursuant to Illinois state law, not federal law; no cases from the state of Iowa appear to have been decided on this issue, although a 2010 case decided by the federal Bankruptcy Appellate Panel for the Eighth Circuit found an inherited IRA was exempt in bankruptcy under federal law (the Eighth Circuit is the federal circuit that has jurisdiction over Iowa, Missouri, Arkansas, Nebraska, South Dakota, North Dakota and Minnesota)).
 
The probability that an inherited IRA will be protected from creditors in bankruptcy is increasing. Individuals facing bankruptcy should nevertheless be cognizant of the cases to the contrary, especially those decided pursuant to state law rather than federal law.  Although overall these cases fall in the minority of court decisions, the risk is still there that a court may find a bankruptcy debtor's inherited IRAs is not exempt from creditors' claims in bankruptcy.
 
Protection of Inherited IRAs in Bankruptcy
 
Submitted by Abigail C. L. Waeyaert
As seen in the September 2011 Quad City Times Business Journal
 
 
 
 
 
Certain property is exempt in bankruptcy, meaning creditors' claims cannot be paid from that property. There are federal and state law bases for exemptions. To some extent, states can "opt out" of the federal law exemptions. Under ERISA, qualified retirement plan benefits, meaning profit sharing and pension plans, 401(k) plans, 403(b) plans and the like, are exempt from the claims of creditors under federal law. In Illinois and Iowa, but not in all states, Individual Retirement Accounts ("IRAs") are generally exempt in bankruptcy, and thus the debtor can keep his or her IRA after declaring bankruptcy. However, this general rule is subject to at least one exception for "inherited IRAs." An inherited IRA is an IRA that is inherited by a non-spouse beneficiary (i.e. you inherit your mother┬ĺs IRA upon her death). The beneficiary cannot treat the inherited IRA as his or her own IRA, meaning the beneficiary cannot make contributions to the inherited IRA or "roll it over" into another retirement plan, and must begin taking distributions immediately.
 
To be exempt under federal law: (1) the inherited IRA must be considered "retirement funds", and (2) the inherited IRA must be exempt from taxation. One of the main issues that divides courts on whether inherited IRAs are exempt is the question of whether the assets are considered "retirement funds." Some courts have taken the position that because the funds in the IRA were literally retirement funds of the original owner of the IRA, it makes no difference that the funds are not technically the retirement funds of the inherited IRA beneficiary. Other courts take a strict approach, finding
that the assets of the inherited IRA are not the retirement funds of the current beneficiary, noting differences in the treatment of traditional IRAs, such as the right to make contributions and defer distributions, as compared to inherited IRAs, and thus are not exempt. The courts that find inherited IRAs are not exempt also dissect and criticize justifications for finding inherited IRAs are exempt from taxation.
 
The trend appears to be to allow the exemption for inherited IRAs, but there continue to be courts that will disallow such exemptions. To illustrate the continuing uncertainty, consider two United States Bankruptcy Court decisions from May 2011. In one decision rendered by the Court in Washington, the court found the debtor's inherited IRAs to be exempt under federal law. In contrast, a decision rendered by the Court in Wisconsin determined an inherited IRA met neither of the two above-cited requirements for exemption, even after noting several decisions in the prior year finding inherited IRAs exempt.
 
Individuals in Illinois and Iowa also face uncertainty as to whether an inherited IRA will be exempt. A 2006 case from the state of Illinois determined inherited IRAs are not exempt in bankruptcy under Illinois law. While no cases from the state of Iowa appear to have been decided on this issue, a 2010 case decided by the federal Bankruptcy Appellate Panel for the Eighth Circuit (which includes Iowa) found an inherited IRA was exempt in bankruptcy under federal law.
 
Given the continuing conflicting court decisions on this issue, it appears the determination of whether inherited IRAs are exempt in bankruptcy will continue to be uncertain, and thus continually litigated, until Congress amends or clarifies the exemption or the U.S. Supreme Court renders a decision on the issue. Until that time, plausible arguments can be made, and have been successful, for both finding inherited IRAs exempt and non-exempt.
 
For more information on this topic please contact Califf & Harper, P.C. by calling 309-764-8300 or 1-888-764-4999. This article is intended to provide general information regarding the topic discussed herein but is not intended to constitute individual legal advice.