Academic journal article Journal of Accountancy

Asset Protection of Retirement Funds after Clark: Supreme Court Decision Denies Exclusion of an Inherited IRA from a Bankruptcy Estate

Academic journal article Journal of Accountancy

Asset Protection of Retirement Funds after Clark: Supreme Court Decision Denies Exclusion of an Inherited IRA from a Bankruptcy Estate

Article excerpt

What's in a name? According to the U.S. Supreme Court, nothing.

In June, the Supreme Court in Clark v. Rameker, No. 13-299 (U.S. 6/12/14), said that just because funds are held in an account called an individual retirement account (IRA), it doesn't necessarily mean that they are retirement funds. And if they are not retirement funds, they are not excluded from a bankruptcy estate under Section 522(b)(3)(C) of the Bankruptcy Code (11 U.S.C. [section] 522(b)(3)(C)).

That section of the Bankruptcy Code provides that a debtor may exempt from the bankruptcy estate retirement funds "to the extent that those funds are in a fund or account that is exempt from taxation" under Sec. 401, 403, 408 (traditional IRAs), 408A (Roth IRAs), 414, 457, or 501(a).

This article examines the implications of the Supreme Court's Clark decision, as well as treatment of IRAs outside bankruptcy under state laws. It suggests how taxpayers and their advisers may nonetheless achieve a degree of asset protection from creditors for inherited IRAs. Specifically, with either of two types of "see-through" trusts, an IRA owner may designate an individual as the trust's beneficiary to receive IRA distributions. A "conduit trust" protects the balance of the inherited IRA from creditors of the trust beneficiary. Alternatively, a discretionary or "accumulation" trust also provides asset protection while also allowing the trustee discretion in making minimum required distributions.

BACKGROUND

In October 2010, Heidi Heffron-Clark and her husband filed a Chapter 7 bankruptcy petition. They identified an IRA that Heffron-Clark had inherited from her mother, which was then worth approximately $300,000, as exempt from the bankruptcy estate under Section 522(b)(3)(C) of the Bankruptcy Code. The bankruptcy trustee and the unsecured creditors of the estate objected to the claimed exemption of the debtor's inherited IRA on the grounds that the funds in the inherited IRA were not "retirement funds" within the meaning of the statute.

Bankruptcy court. The bankruptcy court agreed with the bankruptcy trustee and the unsecured creditors and disallowed the exemption (In re Clark, 450 B.R. 858 (Bankr. W.D. Wis. 2011)). The bankruptcy court relied on what it said was the plain language of Section 522(b)(3)(C) of the Bankruptcy Code and concluded that an inherited IRA "does not contain anyone's 'retirement funds,'" because unlike a traditional IRA, the funds in an inherited IRA "are not segregated to meet the needs of, nor distributed on the occasion of, any person's retirement" (id., at 863).

District and circuit courts. The district court reversed, determining that the exemption covers any account containing funds originally "accumulated for retirement purposes" (Clark v. Rameker, 466 B.R. 135, 139 (W.D. Wis. 2012)). The Seventh Circuit then reversed the district court's judgment, stating that the different rules governing inherited and non-inherited IRAs mean that "inherited IRAs represent an opportunity for current consumption, not a fund of retirement savings" (In re Clark, 714 F.3d 559, 562 (7th Cir. 2013)).

THE SUPREME COURT'S DECISION

The Supreme Court agreed to hear the case to resolve the conflict between the Seventh Circuit's Clark decision and the Fifth Circuit's decision in In re Chilton, 674 F.3d 486 (5th Cir. 2012) (holding that inherited IRAs are "retirement funds" under Section 522(b)(3)(C) of the Bankruptcy Code). The Supreme Court affirmed the Seventh Circuit's decision in Clark, holding that funds held in inherited IRAs are not "retirement funds" within the meaning of Section 522(b)(3)(C) of the Bankruptcy Code.

As a preliminary matter, the Supreme Court stated that:

[T]o determine whether funds in an account qualify as "retirement funds," courts should not engage in a case-by-case, fact-intensive examination into whether the debtor actually planned to use the funds for retirement purposes as opposed to current consumption. …

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