IRAs enjoy significant protection from creditors and the bankruptcy trustee. In fact, there are multiple statutory protections. Here in South Carolina–we’re an “opt out” state, so if you file bankruptcy here, you must claim South Carolina exemptions–we have at least three different IRA exemptions, and they all protect IRAs.
But that wasn’t always the case.
I began practicing way back in 1995. For the first 5-10 years of my practice, protecting IRAs wasn’t a slam dunk. One bankruptcy judge was fairly open about her views on the subject–she viewed IRAs as nothing more than a glorified savings account with tax advantages. And if a client was on the young side and had a sizable IRA, I got a bit nervous about the bankruptcy filing.
And then came the U.S. Supreme Court
Then in 2005, the U.S. Supreme Court decided Rousey v. Jacoway, 544 U.S. 320 (2005). That decision addressed the issue of whether an IRA was exempt under 522(d)(10)(E) of the Bankruptcy Code. (And South Carolina has the same exemption, so the decision matters for those claiming South Carolina exemptions, too.) That provision protects the debtor’s rights in “a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service.” The trustee, Jill Jacoway, argued that an IRA didn’t fit within the language of the statute–it wasn’t a “similar plan or contract.” The Court disagreed and found that an IRA was a similar plan or contract and that it also met the “on account of age” requirement.
Because of Rousey and other protections, the IRA issue seemed dead
But it’s not. It’s like one of those low budget Zombie movies–it’s alive! At least a little longer.
Here’s the issue: Are inherited IRAs exempt?
The problem was created when the 7th Circuit Court of Appeals, bless its heart as we say here in the South before we say something negative, held that a debtor may not exempt an inherited IRA in bankruptcy. In re Clark, 714 F.3d 559 (7th Cir. 2013). The decision is a case of “bad facts make bad law” in which the court decided that the debtor could not keep her $300,000 inherited IRA. (Anyone out there ever seen a debtor with a $300,000 inherited IRA?) And, consequently, the court bent over backwards to make a policy justification for departing from the plain language of the applicable statutes.
This decision starkly contrasted with the 5th Circuit’s correctly decided opinion (when you have your own blog, you get to say who’s correct!) in Chilton v. Moser, 674 F.3d 486 (5th Cir. 2012). In Chilton, the 5th Circuit simply reviewed the plain language of the applicable statute and held that the inherited IRA was exempt, stating:
Most of the courts that have analyzed this issue have concluded that inherited IRAs are ‘retirement funds’ as that phrase is used in section 522(d)(12). Nessa, 426 B.R. at 314; In re Kuchta, 434 B.R. 837, 843–44 (Bankr.N.D.Ohio 2010); In re Tabor, 433 B.R. 469, 476 (Bankr.M.D.Pa.2010); In re Thiem, 443 B.R. 832, 843–44 (Bankr.D.Ariz.2011); In re Weilhammer,No. 09–15148–LT7, 2010 WL 3431465, at *4–*6 (Bankr.S.D.Cal. Aug. 30, 2010); In re Stephenson,2011 WL 6152960, at *2–*3, 2011 U.S. Dist. LEXIS 142360, at *7–*8. These courts have noted that the statute does not explicitly limit ‘retirement funds’ to retirement funds that belong to the debtor. See, e.g., Nessa, 426 B.R. at 314. Accordingly, they have reasoned that ‘retirement funds’ can include the funds that others had originally set aside for their retirement, as with inherited IRAs. Id.
So the U.S. Supreme Court will meet the Zombie IRA issue
The showdown will be between (1) the plain meaning, strict constructionist approach and (2) the policy-oriented approach laid out by the 7th Circuit.
And our prediction is…
The authors (me), editors (me), support staff (me) here at the Charleston Bankruptcy Blog predict the following:
1. The plain language, strict constructionist approach will win out.
2. The Court will side with the 5th Circuit’s approach and reverse the 7th Circuit’s decision.
3. Justice Scalia will write the opinion of the Court, and it will be unanimous or close to unanimous.
Because this case is perfect if you analyze it from a judicial politics standpoint. The conservative, strict constructionist Justices (Justice Scalia being the most notable example) will simply read the statutes and see that nowhere in those statutes do they require that the funds be generated by the debtor. If the requirements are met as the 5th Circuit noted, the exemptions apply irrespective of how the debtor gained ownership in the IRA.
The so-called liberal Justices will see that (1) it’s a bad idea to resurrect the zombie IRA exemption issue because it’s already been settled (killed!) by Congress and various state legislatures and that (2) while the facts of the Clark case (the bad facts in which the debtor has $300,000 in her inherited IRA) are extreme, most debtors hurt by the reasoning of the Clark decision won’t have $300,000 in their inherited IRAs. The typical debtor might not have any other retirement funds and the inherited IRA would likely be more modest–say under $50,000, or even under $25,000. And as the Larry Elkin of Wall Street Pit points out, “the Seventh Circuit apparently failed to consider the fact Heffron-Clark’s mother did not incur any obligations to her daughter’s creditors. Did Congress intend that the money she saved for her own retirement – money she never got to spend because of her relatively early death – be used to pay her daughter’s debts?” Well put, Larry.
So both wings of the Court will unite and be all too happy to let Justice Scalia eviscerate the policy-oriented reasoning of the 7th Circuit.
We shall see. Stand by for the update.
And here’s the update: “Inherited IRAs (Redux).” Spoiler alter: I was wrong.