The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.), analyzing a recent decision of interest:
Following the reasoning of Patterson v Shumate, 504 U.S. 753 (1992) rather than that in Clark v Rameker, 573 U.S. 122 (2014), a Bankruptcy Court in the Western District of North Carolina (the Court) concluded that an inherited 401(k) account is not property of the estate and not subject to turnover by the debtor to a chapter 7 trustee. In re Dockins, 2021 WL 2309928 (Bankr. W.D. N.C. June 4, 2021).
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Prior to her marriage to co-debtor Chris Dockins, debtor Holly R. Corbell-Dockins (“the debtor”) was in a relationship with Kirk Morishita (“Decedent”), who was an employee of Wells Fargo. To her surprise, when Decedent died in February 2020, he owned a 401(k) account with Wells Fargo for which the debtor was the beneficiary of record. Wells Fargo notified the debtor in March 2020 that she was the beneficiary and, after she supplied needed information, it set up a 401(k) account in her name in May 2020. Wells Fargo advised the debtor that she was required to take a full distribution of the account balance by December 31 of the year five years after Decedent’s death.
In the meantime, the debtor had filed a chapter 7 petition in April 2020. At the 341(a) meeting of creditors, she advised the trustee of the inherited 401(k), which was not scheduled because its existence was unknown when the schedules were prepared. Her attorney took the position that amending the schedules was unnecessary because the inherited account was not property of the estate under section 541(c)(2) of the Bankruptcy Code (the “Code”) and the reasoning of Patterson v Shumate. The trustee nevertheless brought a motion for turnover, asserting that the account was property of the estate and, under the reasoning of Clark, could not be exempted under Code section 522(b)(3)(C) because it did not qualify as “retirement funds.”
In Patterson v Shumate the Supreme Court had observed that Code section 541(c)(2) provides that “a restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under” the Code and that the phrase “applicable nonbankruptcy law” includes ERISA-qualified plans. Therefore, the Supreme Court concluded that ERISA-qualified retirement plans were not property of a bankruptcy estate. To the contrary, in Clark, the Supreme Court held than an inherited IRA could not be exempted under Code section 522(b)(3)(C) because the funds did not qualify as “retirement funds.” The argument that the account was not property of the estate was inapplicable, since the IRA was not ERISA-qualified.
After briefing and a hearing, the Court agreed with the debtor that the account was not property of the estate and denied the turnover motion.
Deciding a matter of first impression for the Court, it first highlighted the differences between the two inherited accounts. Section 408(d)(3)(C)(ii) of Title 26 governs inherited IRAs, which are not ERISA-qualified plans. In contrast, a 401(k) plan is a qualified plan under ERISA and “qualifies for tax benefits and protections that an IRA does not.” Key to the ERISA analysis was the anti-alienation or assignment restrictions which are compelled by the Internal Revenue Code, that the Supreme Court in Patterson had deemed enforceable in bankruptcy proceedings. The Court therefore concluded “401(k) plans contain enforceable transfer restrictions for purposes of section 541(c)(2)’s exclusion of property from the bankruptcy estate.”
The Court noted that an inherited 401(k) shares some of the same legal characteristics as an inherited IRA, including that the debtor could not invest additional funds, she must withdraw the funds within a certain amount of time, and she was entitled to withdraw the entire amount in the fund without penalty. Nevertheless, the Court found far more similarities to the Patterson analysis than to Clark. The focus of the Clark court was on the “retirement funds” definition of Code section 522(b)(3)(C), whereas the section 541(c)(2) analysis in Patterson did not mention that term. Most important was the transfer restriction “enforceable under applicable nonbankruptcy law.” Because Patterson supported giving that restriction a “great deal of protection,” the Court reasoned that policy must be primary in the inherited 401(k) analysis. “The purpose and policy of ERISA is to protect the ‘interests of participants in employee benefit plans and their beneficiaries…” causing the Court to conclude the account was excluded from the estate.
The distinctions the Court made between the two types of inherited accounts and the Code sections in play are meaningful. The Supreme Court’s analysis in Clark regarding the exemption issue under Code section 522(b)(3)(C) was entirely separate from its property of the estate analysis under section 541(c)(2). Patterson certainly seems to control and this decision follows that precedent. Troubling to me is the inconsistency of the outcomes. An inherited 401(k) account, which the debtor did not create to protect herself in retirement and which in fact she can withdraw and spend as she sees fit, is not available to her creditors whereas an inherited IRA, which the debtor also did not create to protect herself in retirement, cannot be exempted and can be used by the estate to pay her creditors. Unfortunately, only Congress can fix that anomaly under the legal precedents in play.
This submission was authored by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.) a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.