In a Jan. 10, 2019 ruling, a bankruptcy court held that inherited IRAs ARE protected under Idaho state law!
Interesting case, since back in 2005 the Supreme Court ruled that inherited IRAs were not protected in bankruptcy.
Let’s review Bankruptcy Protection for Retirement Plans
On April 14, 2005, Congress passed The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S. 256). Then-president George Bush signed this legislation into law on April 20, 2005.
The Act contained protection from bankruptcy creditors for certain retirement and education savings. The general effective date was for cases that commenced six months after the date of enactment. When this Act became effective in October 2005, it overshadowed the previous U.S. Supreme Court’s ruling (Rousey v. Jacoway) that, to a limited degree, extended protection of IRA assets from the debtor’s bankruptcy creditors.
Plan assets that are part of an ERISA plan are federally protected from creditors under Title I of ERISA, not just bankruptcy creditors. Keep in mind though: a “qualified plan” may not necessarily be an ERISA plan. For example, a 401(k) profit sharing plan that benefits only the business owner and/or the owner’s spouse is not federally protected from creditors under Title I of ERISA. In this case, protection from creditors would only be available under State law, if applicable.
Individual Retirement Accounts (IRAs), including SEP IRAs, SIMPLE IRAs and Roth IRAs are generally not considered ERISA plans for purposes of Title I of ERISA. However, some states either fully or partially protect IRA assets from creditors, or may provide for limited protection in the event of bankruptcy.
What Plans Are protected Under the Act?
Retirement funds that are exempt from taxation and governed under the following Code sections are protected from the debtor’s bankruptcy creditors:
1. Qualified Plans under §401 (defined benefit plans, defined contribution plans);
2. Plans under §403 (qualified annuity plans, §403(b) annuities, §403(b)(7) custodial accounts, §403(b)(9) retirement income church accounts);
3. IRAs under §408 (Traditional IRAs, SEP IRAs, SIMPLE IRAs);
4. Roth IRAs under §408A;
5. Plans under §414 (governmental plans, church plans, multiemployer plans);
6. Plans under §457 (eligible §457(b) plans, ineligible §457(f) plans); and
7. Plans under §501(a).
The Act also extends protection to direct rollovers or distributions that are rolled over within the requisite 60-day period from a plan listed above to another such eligible plan.
Limits on Protection
Balances held in traditional IRAs and Roth IRAs:
- In the aggregate, are capped at $1 million (indexed for inflation – $1.2 million currently and slated for adjustment on April 1, 2019) for purposes of being excluded from the bankruptcy estate.
- For purposes of this cap, SEP IRAs, SIMPLE IRAs and amounts attributable to rollovers from employer-sponsored plans are not included. Thus, the $1 million cap (indexed for inflation) applies only to regular contributions made to Traditional IRAs and balances held in Roth IRAs plus earnings attributable thereto.
Amounts in a Coverdell Education Savings Account or in a §529 qualified tuition program are protected from the debtor’s bankruptcy creditors, but certain rules and exceptions apply to these accounts as follows:
- Contributions must have been made at least 365 days before the date of the filing of the case.
- Contributions benefiting the same designated beneficiary must have been made no earlier than 720 days but at least 365 days before the date of the filing of the case. In this situation, the maximum amount excluded from the debtor’s bankruptcy estate is $5,000.
- The account benefiting the designated beneficiary must be the debtor’s child, stepchild, grandchild, or step-grandchild. For purposes of this rule, a legally adopted child, a child who is a member of the debtor’s household if placed with such individual by an authorized placement agency for legal adoption, or a foster child are treated as a child by blood.
- Qualified Tuition Program accounts for the same designated beneficiary are also generally capped at $5,000.
And the Supreme Court Rules!
On June 12, 2014, in Clark v. Rameker Trustee, No. 13-299, the Supreme Court ruled that inherited IRAs are not exempt from bankruptcy as “retirement plan assets.” Keep in mind, this case was based on a nonspouse beneficiary (child of the IRA participant) which had a hand in the final ruling.
In the arguments, the trustee of the bankruptcy estate argued that inherited IRAs differ from the typical retirement fund in three ways:
1. The beneficiary may never deposit more funds into the inherited IRA for retirement;
2. RMDs must be made from the account no matter how far from retirement age the beneficiary may be; and
3. May withdraw money from the account at any time without a penalty (demand account).
The court summed up the case by saying that “funds held in an inherited IRA accordingly constitute a pot of money that can be freely used for current consumption, not funds objectively set aside for one’s retirement.” The court did note that if the beneficiary was a spouse of the participant, such a beneficiary could roll the assets to their own IRA or assume the IRA, in which case the IRA would be covered under the bankruptcy protection.
Fast Forward to 2019
The taxpayer in this case inherited the IRA from his mother and claimed that the IRA was exempt from bankruptcy under state law (Idaho). Even though the Supreme Court ruled that inherited IRAs are not considered retirement funds, the court found that the Idaho state law was worded differently and is broad enough to encompass inherited IRAs. (Arehart, No. 17-01678-TLM (Bankr. D. Idaho Jan. 10, 2019)).
Moral of the Story
Check your state law before claiming that an inherited IRA is not protected from a bankruptcy claim!
Susan D. Diehl, CPC, QPA, ERPA, is President, PenServ Plan Services, Inc. and Chair of the NTSA Communications Committee.
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA or its members.