In “Are Inherited IRAs exempt”, I went out on a limb and predicted that the U.S. Supreme Court would rule–as did the 5th Circuit Court of Appeals–that inherited IRAs were exempt under section 522 of the Bankruptcy Code. I promised an update when the decision came out, which happened several months ago, and it’s time for me to own up to the fact that I was wrong.
And here’s the update
In Clark v. Rameker, 573 U.S. ___ (2014), the U.S. Supreme Court sided with the 7th Circuit Court of Appeals and held that inherited IRAs are not exempt under the federal exemption statute found in section 522 of the Bankruptcy Code. The Court’s analysis was that because the IRA was inherited, it was no longer a “retirement account” in the hands of the debtor. The debtor (under the inherited IRA rules) could withdraw the IRA for any purpose, no longer had the right to contribute to the IRA, and was required to take the IRA as a distribution within five years of inheriting it. The Court, therefore, reasoned that the inherited IRA should not be protected because it wasn’t a “retirement account” in the hands of the debtor.
A couple of things are interesting about this issue. First, it occurs to me that if someone is over age 70.5, he, too, cannot contribute to a regular IRA (Roth rules are a little different), must take mandatory distributions from the IRA, and can withdraw the funds for any reason. Admittedly, the rules aren’t exactly the same, but there are striking similarities.
But the Court has spoken. And in my 20 years practicing law, I’ve never had a client with a large amount of money in an inherited IRA, so this is largely an academic question. This almost never happens–especially with an IRA with $300,000 in it at filing.
Second, and most importantly, this really isn’t a problem for those filing bankruptcy in South Carolina. South Carolina is an “opt out” state, meaning that debtors must use South Carolina exemptions, not the exemptions in the Bankruptcy Code that were at issue in the Clark case. (Note, that to use South Carolina exemptions, debtors must be domiciled in South Carolina for two years prior to filing. Choice of law provisions regarding exemptions are complicated and beyond the scope of this post.)
Under S.C. Code Ann. § 15-41-30(A)(13) IRAs are exempt “whether such individual has an interest in the retirement plan as a participant, beneficiary, contingent annuitant, alternate payee, or otherwise.” Owning an IRA as a “beneficiary” means that the debtor inherited it, so to speak.
All things considered, if I had a client with an inherited IRA, I would proceed cautiously. The main concern would be to make sure the client was eligible to claim South Carolina exemptions. As a backup (belt and suspenders as I say) I’d also consider filing a Chapter 13 bankruptcy because if the exemption was disallowed, the debtor could dismiss the Chapter 13 and explore other options. Dismissal must be approved by the bankruptcy court in Chapter 7, and the court usually doesn’t allow the case to be dismissed simply because the debtor miscalculated property exemptions.
Debtors in states with no such protection (non opt-out states or opt-out states without language similar to our statute) are in a difficult situation if they have a large inherited IRA and should seek experienced bankruptcy counsel.
