The U.S. Supreme Court recently ruled that inherited individual retirement accounts (IRAs) are not exempt assets for bankruptcy purposes, and thus can be used to satisfy the claims of bankruptcy creditors. In Clark v. Rameker, the debtor had inherited an IRA from her deceased mother. When the debtor and her husband filed for bankruptcy nine years later, they identified the IRA as “retirement funds” exempt from the bankruptcy estate. The bankruptcy trustee and unsecured creditors objected to the designation of the IRA as “retirement funds.” The Bankruptcy Court agreed with the trustee, but the District Court reversed. The Seventh Circuit Court of Appeals then held that the IRA was not exempt, agreeing with the trustee. In contrast, the Fifth and Eighth Circuits have previously held that an inherited IRA qualifies for the exemption because the funds were someone’s retirement funds at an earlier time. Chilton v. Moser, 674 F.3d 486 (5th Cir. 2012); Doeling v. Ness, 426 B.R. 312 (8th Cir. 2010).
In agreeing with the Seventh Circuit, the U.S. Supreme Court looked at the differences between an inherited IRA and other IRAs, as well as the policies underlying bankruptcy exemptions. Unlike a traditional or Roth IRA (which is exempt in bankruptcy), the holder of an inherited IRA (1) may not add funds to the account, (2) is required to withdraw funds from the account, no matter how many years the holder is from retirement, and (3) may withdraw the entire balance at any time and for any purpose without penalty. These characteristics show that an inherited IRA is not objectively set aside for retirement, and thus does not qualify as “retirement funds” exempt from bankruptcy. Furthermore, the purpose of the bankruptcy exemption for retirement funds is to allow the debtor to meet his or her basic needs in his retirement years. In contrast, because the funds in an inherited IRA may be withdrawn at any time without penalty, allowing their exemption in bankruptcy would represent a cash windfall to the debtor.