The United States Supreme Court has ruled that inherited Individual Retirement Accounts (IRAs) are not protected under federal exemption laws. Clark v. Ramekers, 573 U.S. ____ (2014). Even though inherited IRAs are exempt under federal income tax laws, the court said they are not really “retirement funds” under Section 522(b)(3)(C) of the Bankruptcy Code. Justice Sotomayor cited three key legal characteristics of inherited IRA accounts that are exactly opposite of how normal retirement funds operate:
- The inherited IRA recipient may never invest additional money into the account.
- Inherited IRA beneficiaries must withdraw funds from the account right now regardless of how many years they have to retire.
- There is no tax penalty for withdrawing funds from an inherited IRA.
Whereas normal retirement accounts allow ongoing contributions, encourage savers to keep funds in the account and penalize those who take out money early, inherited IRAs do the opposite and thus are not really “retirement funds” in the eyes of the Supreme Court. Although some beneficiaries may use the inherited funds for retirement, the Court was not satisfied.
The possibility that some investors may use their inherited IRAs for retirement purposes does not mean that inherited IRAS bear the defining legal characteristics of retirement funds.
Although a spouse may roll over an inherited IRA to his or her own IRA account and thus exempt the funds, children may not take advantage of the roll over option.
So, what is the status of inherited IRA accounts in Nebraska? In addition to the federal exemption provided under §522(b)(3)(C), Nebraska has traditionally allowed debtors to exempt IRA accounts under Nebraska Statute 25-1563.01. That statute exempts “to the extent reasonably necessary for the support of the debtor and any dependent of the debtor, an interest held under a stock bonus, pension, profit-sharing, or similar plan or contract payable on account of illness, disability, death, age, or length of service.”
Is an inherited IRA account a retirement fund that is “payable on account of illness, disability, death, age or lenght of service” of a debtor in a Nebraska bankruptcy case? The same arguments used by Justice Sotomayor against extending the federal exemption to inherited IRA accounts could also be used aginst the Nebraska exemption statute as well. So, until there is a new local ruling on this topic I would assume that all inherited IRA accounts are at risk in bankruptcy.
Image courtesy of Flickr and State Library of New South Wales.