Supreme Court holds inherited IRAs are not retirement funds
By Sally P. Schreiber, J.D.
June 12, 2014 - Journal of Accountancy
In a unanimous opinion written by Justice Sonia Sotomayor, the
U.S. Supreme Court on Thursday held that funds from an inherited IRA were not
retirement funds that were exempt from the debtorfs bankruptcy estate (Clark v. Rameker, No. 13-299 (U.S. 6/12/14), afffg 714
F.3d 559 (7th Cir. 2013)). The Supreme Court granted certiorari to
resolve a split between the Seventh Circuit and the Fifth Circuit (in In re
Chilton, 674 F.3d 486 (2012)), and affirmed the Seventh Circuitfs decision
in Clark.
The taxpayers in the case filed for Chapter 7 bankruptcy and
sought to exclude approximately $300,000 in an inherited IRA from the bankruptcy
estate on the grounds that the money was gretirement fundsh under Section
522(b)(3)(C) of the Bankruptcy Code (11 U.S.C. ˜522(b)(3)(C)).
Bankruptcy Code Section 522(b)(3)(C) excludes retirement funds
from a bankruptcy estate to the extent those funds are in a fund or account that
is exempt from taxation under Sec. 401, 403, 408, 408A, 414, 457, or 501(a).
However, as the Supreme Court explained, although traditional retirement
accounts, such as IRAs or Roth IRAs, are included in this definition, inherited
IRAs are not because they do not operate as retirement accounts.
The Supreme Court pointed to three legal characteristics of
inherited IRAs that led it to conclude they are not retirement accounts. First,
inherited IRA owners may not make additional contributions to the account.
Second, owners must withdraw funds from their accounts, regardless of how many
years they are from retirement. Third, owners are not subject to any age-related
penalties for withdrawals from their accounts. Taking all of these
characteristics together, the Supreme Court agreed with the Seventh Circuit that
g[f]unds held in inherited IRAs accordingly constitute ea pot of money that can
be freely used for current consumption,f ... not funds objectively set aside for
onefs retirementh (Clark, slip op. at 6, quoting the circuit court
(citations omitted)).
According to the Supreme Court, allowing debtors to protect
funds in traditional retirement accounts, but not inherited IRAs, permits the
Bankruptcy Code to achieve a balance between debtors and creditors. Debtors are
assured that they will be able to meet their basic needs during their retirement
years. Allowing bankruptcy exemptions for funds that are not restricted to use
for retirement, as inherited IRAs are not, would allow debtors to use those
funds for current consumption after bankruptcy proceedings are complete,
changing the Bankruptcy Codefs gefresh startf into a efree passfh
(Clark, slip op. at 7 (citations omitted)).
The Court rejected the debtorfs argument that, because the
account was originally a retirement account when the debtorfs mother created it,
it retained that character after it was inherited. According to the Court, the
use of the term geretirement fundsf implies that the funds are currently in an
account set aside for retirement, not that they were set aside for that purpose
at some prior date by an entirely different personh (Clark, slip op. at
8).
—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA
senior editor.