U.S. Supreme Court:  “Inherited IRAs Are Not Retirement Funds”

On June 12, 2014, the United States Supreme Court, in the case of Clark et ux v. Rameker, Trustee, et al., ruled that funds held in an “inherited IRA” are not retirement funds within the meaning of Section 522(b)(3)(C) of the Bankruptcy Code. Therefore, the funds are subject to creditors’ claims in bankruptcy and are not exempt from an IRA holder’s bankruptcy estate.

In Clark, Ruth Heffron established a traditional IRA and named her daughter, Heidi Heffron-Clark, as the sole beneficiary. When Ruth died, the IRA became an “inherited IRA”.  After Heidi and her husband filed a Chapter 7 bankruptcy petition some years later, they claimed that the inherited IRA was excluded from the bankruptcy estate as a “retirement fund”. The Bankruptcy Court disagreed, holding that an inherited IRA is not a retirement fund and therefore is not exempt from the bankruptcy estate. The District Court reversed, finding that the exemption covers any account containing funds originally accumulated for retirement. On appeal, the Seventh Circuit reversed the District Court’s ruling.

In June, the Supreme Court unanimously ruled on the issue, noting that the Bankruptcy Code does not define “retirement funds.”  The Court, therefore, looked to the ordinary meaning of the term and concluded that retirement funds are “sums of money set aside for the day an individual stops working.” The Court stated that the following three characteristics of inherited IRAs necessitated its finding that funds held in such accounts are not set aside for retirement:

  1. The holder of an inherited IRA may not put additional money in the account;
  2. The holder of  an inherited IRA is required to withdraw money from such accounts, regardless of his or her age or of how many years he or she is from retirement;
  3. The holder of an inherited IRA may withdraw the entire balance at any time for any purpose without penalty.  This is not the case with a traditional or Roth IRA, where withdrawal before a certain age (59 ½) triggers a 10 percent penalty unless an exception applies.

Based on the above characteristics, the Supreme Court held that funds contained in an inherited IRA constitute money that can be freely used and are not funds objectively set aside for one’s retirement.  Therefore, the Court must favor creditors where inherited IRAs are concerned.  This important Supreme Court decision reminds us of the necessity of proper estate planning and of the need to review and update estate plans periodically, as changing circumstances may dictate.

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