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"Supreme Court Holds Inherited IRAs are Not Exempt in Bankruptcy"

June 13, 2014

Resolving a split among the U.S. Circuit Courts of Appeal, the U.S. Supreme Court in Clark v. Rameker issued its unanimous opinion on June 12, 2014, determining that assets held in an inherited individual retirement account (IRA) are not exempt from creditors in bankruptcy proceedings.

In the Clark case, Heidi Heffron-Clark and her spouse declared bankruptcy in October 2010, disclosing her ownership of an IRA inherited from her mother, Ruth Heffron valued at approximately $300,000. Heffron-Clark claimed such funds were exempt “retirement funds” pursuant to 11 U.S.C. § 522(b)(3) (“an individual debtor may exempt from property of the estate . . . (C) retirement funds to the extent that those funds are in a fund or account that is exempt from taxation[.]”). The bankruptcy trustee and the unsecured creditors of the estate objected to Heffron-Clark’s exemption claim. 

Writing for all nine justices, Justice Sonia Sotomayor identified three legal characteristics distinguishing an inherited IRA from other types of retirement accounts that are “objectively set aside for the purpose of retirement.” First, a person who inherits an IRA can never contribute additional assets to the account. Second, the Internal Revenue Code allows withdrawals from an inherited IRA at the owner’s option, without regard to retirement age. And, third, assets held in an inherited IRA may be fully withdrawn, for any purpose, without tax penalties. Based on these distinctions, the Court found that an inherited IRA constitutes “a pot of money that can be freely used for current consumption,” rather than “funds objectively set aside for one’s retirement.”

Bankruptcy exemptions are based on “a careful balance between the interest of creditors and debtors,” and the protection for retirement funds “ensures that debtors will be able to meet their basic needs during their retirement years.” Exempting assets held in traditional and Roth IRAs, with their restrictions that tax-free withdrawals cannot be made until the age of 59 ½, served this purpose. On the other hand, exempting assets held in inherited IRAs, wherein assets may be used “on a vacation home or [a] sports car,” does not.

Firms should ensure their records distinguish between inherited IRAs, which are subject to a bankruptcy trustee’s turnover demand, and self-funded traditional IRAs, which remain exempt.

If you have any questions about the matters covered in this publication, contact any member of Greensfelder's Securities and Financial Services Group or your regular Greensfelder contact.