Almost all forms of retirement are protected. Inherited ones aren’t, unless you are the spouse, or maybe if you live in the right state.
Our last two blog posts have been about the U.S. Supreme Court’s decision handed down on June 12, 2014 in the case Clark v. Rameker. The Court determined that a woman who filed a Chapter 7 case could not exempt—or shelter from her creditors—an Individual Retirement Account (IRA) that she had received years earlier as the beneficiary on her mother’s IRA.
Our very last blog post used this Supreme Court opinion as a good way to get a better understanding of property exemptions in general. Today we use it as way to understand retirement exemptions in particular.
Reminder: What Are Exemptions?
Property exemptions are, as the Supreme Court said in its opinion mentioned above, a way to “help the debtor obtain a fresh start” by allowing that debtor “to exempt from the [bankruptcy case] limited interests in certain kinds of property.” So exemptions consist of a list of certain dollar amounts (usually) of certain kinds of property that a person filing bankruptcy is allowed to keep and does not have to turn over to his or her creditors.
The Practical Effect of Exemptions in Bankruptcy
Under Chapter 7 “liquidation” cases, for most people nothing gets “liquidated” because everything they own fits within the allowed exemptions. The bankruptcy trustee merely verifies that everything the person has is exempt. It is a “no asset” case—the trustee has no assets to liquidate and pay the creditors with.
Under Chapter 13, if everything is exempt then the person does not have a minimum dollar amount that he or she must pay to the general unsecured creditors in order to protect his or her assets. The Chapter 13 plan can instead be dictated by the person’s monthly budget and perhaps by the amount of secured debts (vehicle loan and home mortgage arrearage, for example) and priority debts (recent taxes and support arrearage, for example) that must be paid.
Retirement Exemptions in Particular
The Bankruptcy Code allows debtors to protect their retirement accounts very broadly. It protects “retirement funds to the extent those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457,or 501(a) of the Internal Revenue Code.” These sections refer to:
401: Qualified pension, profit-sharing, and stock bonus plans
403: Employee Annuities
408: Individual Retirement Accounts (traditional IRAs)
408A: Roth IRAs
414: Governmental, church, and multiemployer plans
457: Deferred compensation plans of State and local governments and tax-exempt organizations
501(a): The tax exemption provisions
How Did the Supreme Court Unanimously Decide that the Debtor’s IRA Was Not Exempt?
Referring to the Bankruptcy Code’s language quoted in the above paragraph, the Court said that it’s not enough that an account is exempt from taxation by being an IRA; the account had to be “retirement funds” as well. As the Court’s opinion stated:
In other words, [the above statute’s language] requires that funds satisfy not one but two conditions in order to be exempt: the funds must be “retirement funds,” and they must be held in a covered account. [This follows] the rule that “‘a statute should be construed so that effect is given to all its provisions, so that no part will be inoperative or superfluous.’”(Citations omitted.)
The Court then determined that an inherited IRA does not meet the conditions necessary for being “retirement funds”—see two blog posts ago where we described the three conditions focused on by the court.
Can An IRA or Other Kind of Retirement Ever Be Exempt in the Hands of a Decedent’s Beneficiary?
In spite of the Supreme Court’s strong ruling, there are at least two possible exceptions:
1. Spouses: The Court specifically referred to a special provision in the law relating to spouses inheriting an IRA:
If the heir is the owner’s spouse, as is often the case, the spouse has a choice: He or she may “roll over” the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA (subject to the rules discussed below [referring presumably to its ruling making inherited IRAs not exempt in bankruptcy]).
The very clear implication here is that if the spouse takes the first choice and rolls over the decedent spouse’s IRA “into his or her own IRA,” that would be exempt from creditors. Non-spouse beneficiaries do not have the rollover option and must hold the IRA as an inherited account, as happened with the debtor in the case before the Supreme Court, who inherited the IRA from her mother.
2. State Laws Which Exempt Inherited IRAs: As the Court acknowledged in a footnote, “debtors may claim exemptions either under federal law… or state law… .”
(Actually, in about 30 states debtors MUST use the state’s exemptions and can’t use the federal exemptions—see our last blog post about this. But for our immediate purpose here, in all 50 states debtors have the option of using the exemptions contained in their state’s laws.)
State exemptions often are more generous than the federal ones, and federal bankruptcy law generally allows them to be. So if a state decides to clearly exempt INHERITED IRAs, its residents filing bankruptcy can choose to use the state’s exemptions, including the inherited IRA exemption. Something like seven states have changed their exemption provisions in the last few years exactly in this way.
This may well be complicated by the fact that the Bankruptcy Code includes the sentence quoted above about “retirement funds” in its references to BOTH the federal and state exemptions. So there may be an argument that this language—which made inherited IRAs not exempt according to the Supreme Court—directly conflicts with and thus trumps any effort in state law to broaden the exemption to inherited IRAs.
Stay tuned. Most Supreme Court opinions, even relatively clear ones like this one, open up new questions that then have to be resolved over time. It’s no different here.