With the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, it became clear that Traditional IRAs and Roth IRAs had creditor protection if the IRA owner filed for bankruptcy. However, it has not been clear to what extent, if any, an “inherited IRA” would be protected in bankruptcy. An IRA is treated as “inherited” if the individual for whose benefit the account is maintained acquired such account by reason of the death of another individual and such individual is not the surviving spouse of the deceased individual. But that uncertainty has now been removed.
In a recent decision by the US Supreme Court, Clark v. Rameker, 113 AFTR 2d Par. 2014-889, it was unanimously held that inherited IRAs do not qualify for a bankruptcy exemption, i.e. they are not protected from creditors in bankruptcy.
Under Bankruptcy Code Section 522(b)(3)(C) , a debtor may exempt amounts that are both (1) “retirement funds, “ and (2) exempt from income tax under one of several specified Internal Revenue Code sections, including IRC Section 408, which provides a tax exemption for IRAs.
In 2001, Heidi Heffron-Clark inherited her deceased mother’s traditional IRA as sole beneficiary. The IRA was worth about $450,000. Heidi and her husband Brandon (the Clarks) elected to take monthly distributions from the IRA as the way for Heidi to comply with the required minimum distribution rules.
In 2010, the Clarks filed a bankruptcy petition under Chapter 7 of the Bankruptcy Code. In their petition, the Clarks sought to exempt the inherited IRA, then worth about $300,000, from their bankruptcy estate, via Bankruptcy Code Section 522(b)(3)(C). The bankruptcy trustee and the Clarks’ unsecured creditors objected, arguing that the funds held in the inherited IRA were not “retirement funds” within the meaning of Bankruptcy Code Section 522(b)(3)(C), and so could not be exempted from the bankruptcy estate under that provision. The bankruptcy court agreed, finding that inherited IRAs don’t hold “anyone’s” retirement funds because the funds are not set aside for retirement needs, nor are they distributed upon retirement.
The bankruptcy court’s decision was appealed to a federal district court, which reversed the decision and held that the inherited IRA did qualify for the Bankruptcy Code Section 522(b)(3)(C) exemption. This decision was then appealed to the Seventh Circuit, which determined that the bankruptcy court had gotten it right and that Heidi Clark’s inherited IRA did not qualify for the Bankruptcy Code Section 522(b)(3)(C) exemption.
Split among the Federal Circuit Courts.
The Seventh Circuit’s decision was at odds with an earlier holding by the Fifth Circuit in its In Re Chilton decision . With this split among the Federal Circuits, the US Supreme Court agreed to hear the case to resolve the split among the courts.
Supreme Court Says “No Exemption”.
Justice Sotomayor delivered the opinion for a unanimous court, stating that “text and purpose’ of the Bankruptcy Code provided that funds held in inherited IRAs are not “retirement funds” for purposes of the Bankruptcy Code 522(b)(3)(C) exemption.
The second part of this blog will describe the reasons why the U.S. Supreme Court determined that an inherited IRA is not a “retirement fund” as that phrase is used in the Bankruptcy Code.  11 USC 522(b)(3)(C)
 674 F. 3d 486 (5th Cir. 2012)