Business Law

Diana Herman’s e-Bulletin re Clark v. Rameker

Dear constituency list members of the Insolvency Law Committee, the following is a recent case update:   

SUMMARY

On June 12, 2014, in Clark v. Rameker, the United States Supreme Court unanimously held that funds held in inherited IRAs are not “retirement funds” within the meaning of 11 U.S.C. §522(b)(3)(C) and are therefore not exempt property.  To read the full decision, click here:  http://www.supremecourt.gov/opinions/13pdf/13-299_6k4c.pdf

FACTS

In 2001, Heidi Heffron-Clark inherited an individual retirement account (“IRA”) worth roughly $450,000 from her mother’s estate.  Heffron-Clark and her husband (“Debtors”) filed for bankruptcy in October 2010 and sought to exclude the $300,000 in funds remaining in the IRA as exempt under 11 U.S.C. §522(b)(3)(C).  The Chapter 7 trustee and unsecured creditors objected to the claimed exemption on the ground that the funds in the inherited IRA were not “retirement funds” within the meaning of the statute. 

The bankruptcy court disallowed the Debtors’ claimed exemption and held that the inherited retirement funds must be held for the current owner’s retirement in order to qualify as an exempt retirement fund under 11 U.S.C. §522(b)(3)(C).  The district court reversed and held that the exemption covers any account containing funds originally accumulated for retirement purposes.  The U.S. Court of Appeals for the Seventh Circuit (“Seventh Circuit”) reversed the district court and disallowed the exemption, holding that the rules for inherited IRAs, unlike the rules for non-inherited IRAs, require the owner to withdraw the funds in the account (either within five years of the original owner’s death or through minimum annual distributions), so inherited IRAs “represent an opportunity for current consumption, not a fund of retirement savings.” 

RULING

The Supreme Court affirmed the Seventh Circuit’s decision, holding that the funds in an inherited IRA are not set aside for the debtor’s retirement and thus are not “retirement funds” under the exemption in 11 U.S.C. § 522(b)(3)(C).  The Court examined three legal characteristics of inherited IRAs in determining whether the funds are objectively set aside for the purpose of retirement.  First, unlike traditional IRAs, the holder of an inherited IRA is prohibited from investing additional money in the account.  Second, the holder of an inherited IRAs is required to take minimum annual distributions every year, no matter how many years they are from retirement. Finally, unlike traditional IRAs, the holder of an inherited IRA may withdraw the entire balance of the account at any time and for any reason without penalty.

Based on these three legal characteristics, the Court held that inherited IRAs cannot be treated as an exempt “retirement fund” under Section 522.  The Court reasoned that if an individual were to be “allowed to exempt any inherited IRA from her bankruptcy estate, nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete.”  The Court held that this would frustrate the balance between ensuring creditor recoveries while protecting the debtor’s essential needs during their retirement years and enabling a “fresh start.” 

AUTHOR’S COMMENTARY

While the Supreme Court’s opinion dealt with an IRA inherited by a child from a parent, the Court noted that IRAs inherited by spouses may be treated differently.  In particular, the Court noted the distinction between an IRA inherited from a parent and an IRA inherited from a spouse.  Unlike an IRA inherited from a parent, when the heir to an inherited IRA is the owner’s spouse, the spouse “may ‘roll over’ the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA” subject to the applicable rules. 

These materials were written by ILC member Diana Herman (dherman@mckennalong.com), of counsel at McKenna Long Aldridge LLP, in San Francisco, California, with editorial contributions from ILC member Michael J. Gomez of Lang, Richert & Patch, P.C., in Fresno, California.

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