Knowing When to Walk Away
Earlier this month, the Supreme Court issued a unanimous ruling in Clark v. Rameker, 573 U.S. __ (2014) holding that inherited IRAs do not qualify for the retirement funds exemption in 11 U.S.C. 522(b)(3)(C).
Section 522(b)(3)(C) permits a debtor to exempt from property of the estate the following:
"retirement funds to the extent that 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 of 1986."
An "inherited IRA" is a category of retirement account that is specified in 26 U.S.C. 408A(d)(3)(C)(ii), and which constitutes "a traditional or Rother IRA that has been inherited after its owner's death." See Clark at 2. If the account owner's spouse is the inheritee, he or she may elect to either roll the funds into his or her own IRA, or may keep the money in an "inherited IRA" subject to several rules and restrictions. If a non-spouse inherits the account, that person's only option is to hold it as an inherited IRA.
An inherited IRA differs from either a traditional IRA or a Roth IRA in many respects. First, the individual owner may utilize the fund for current consumption, and may withdraw money without any additional tax penalties. Second, the owner must either "withdraw the entire balance in the account within five years of the original owner's death or take minimum distributions on an annual basis." Id. Third, the owner of an inherited IRA may not make contributions to the account. Id.
At issue in Clark was whether the undefined term "retirement funds" as used in Section 522 encompassed inherited IRAs. The Court found that the term should not encompasses these accounts, because the "legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objectively set aside for the purposes of retirement." Id. at 5. The Court held that the policy behind Section 522's retirement fund exemption was to "protect the debtor's essential needs," and that this policy would be subverted if the fund were exempt, because "nothing ... would prevent the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete."