An Individual Retirement Account no longer consists of “retirement funds” once it is transferrd to a beneficiary. So it’s not exempt.
The U.S. Supreme Court usually hands down only a handful of decisions each year directly about bankruptcy. So when it does, we pay attention.
It issued one earlier this month in a case called Clark v. Rameker. The Court ruled that a woman who had filed a Chapter 7 case could not shelter from her creditors an Individual Retirement Account (IRA) that she had inherited, worth $300,000 at the time of the bankruptcy.
The Facts and Lower Court Decisions
A woman in Wisconsin, Heidi Heffron-Clark, filed a Chapter 7 “straight bankruptcy” case with her husband in 2010. They had opened a pizza parlor in a town outside Madison, Wisconsin, but it had failed during the recent recession.
Many years before, Heidi’s mother had set up a traditional IRA, with Heidi as the sole beneficiary. When Heidi’s father had died at the age of 52, his IRA was rolled into Heidi’s mother’s IRA. When Heidi’s mother died at the age of 56, he IRA passed to Heidi as the designated beneficiary. Nine years later, after the failure of the pizza parlor, the couple filed bankruptcy, claiming this IRA as “exempt.”
But their Chapter 7 trustee, William Rameker, whose job is to try to get creditors paid from the assets of debtors, objected to the claim of exemption. He argued that an IRA that is inherited does not have the characteristics that make it exempt as a “retirement fund.” The Wisconsin Bankruptcy Court agreed. But when Heidi and her husband appealed the decision to the District Court, it ruled in their favor, overturning the Bankruptcy Court’s decision. However, when in turn the trustee appealed that decision to the Seventh Circuit Court of Appeals, he won again. So Heffron-Clark appealed to the Supreme Court.
The Language of the Statute at Issue
The legal issue was straightforward compared to many cases before the Supreme Court, turning on two words in the Bankruptcy Code.
The federal Bankruptcy Code says that “retirement funds” are exempt from the reach of creditors “to the extent that those funds are in a fund or account that is exempt from taxation under section… 408… of the Internal Revenue Code… .” Section 408 of the Internal Revenue Code is about IRAs.
There was a potential question whether the inherited IRA that Heidi owned at the time the Chapter 7 case was filed continued to be “exempt from taxation under section… 408… of the Internal Revenue Code.” But the Supreme Court focused on the question whether that inherited IRA was a “retirement fund” in the first place.
What Are “Retirement Funds”?
The Bankruptcy Code does not define that term.
The Supreme Court decided however that the “text and purpose of the Bankruptcy Code make clear that funds held in inherited IRAs are not ‘retirement funds’ within the meaning of [the] bankruptcy exemption.”
The Supreme Court’s Rationale
The Court determined that the ordinary meaning of “retirement fund” was “sums of money set aside for the day an individual stops working.” It thus looked “to the legal characteristics of the account in which the funds are held, asking whether, as an objective matter, the account is one set aside for the day when an individual stops working.”
The Court focused on the following three characteristics of inherited IRAs as not being characteristics of a “retirement” account:
- Beneficiaries cannot add money to inherited IRAs like IRA owners can to their own accounts.
- Beneficiaries of inherited IRAs must generally begin to take “required minimum distributions” in the year after they inherit the account, regardless of how far away they are from retirement.
- Beneficiaries can take total distributions of their inherited accounts at any time and use the funds for any purpose without a penalty. They do not have to be retired or any particular age, unlike original IRA owners who must generally wait until 59 ½ before they can take penalty-free distributions.
As a result, the Supreme Court decided that inherited IRAs don’t consist of “retirement funds.” So they are not exempt from the reach of the Chapter 7 trustee on behalf of creditors.