By Charles J. Tabb
Mildred Van Voorhis Jones Chair in Law, University of Illinois, and Resident Scholar for the American Bankruptcy Institute
The United States Supreme Court yesterday heard oral arguments in the case of Clark v. Rameker, on the issue of whether an inherited IRA is exempt. The Seventh Circuit had denied the debtor’s exemption, disagreeing with the Fifth Circuit in the Chilton case, as well as the clear majority of lower courts, which had held that an inherited IRA is exempt under section 522(b)(3)(C) or 522(d)(12) (depending on whether the debtor elects the state or federal exemptions). On balance, while it is a close question, the oral arguments appear to indicate that the Court is likely to reverse the Seventh Circuit and hold for the debtor. My sense is that the Justices do not really like the result as a policy matter but think the Code dictates a pro-exemption reading.
After Heidi Heffron-Clark and her husband Brandon Clark filed chapter 7, Heidi claimed an exemption under section 522(b)(3)(C), for an IRA valued at close to $300,000 that she had inherited from her mother Ruth. The trustee (Rameker) objected. If the trustee wins, the Clarks’ creditors get that money. If the debtor wins, she keeps all of the money for herself, and indeed does not even have to wait until she is retirement age to start enjoying the funds. It would just be a $300,000 windfall for her (albeit with some tax implications), free from her creditors. Clearly, this was the point at oral argument that most troubled the Justices if they were to hold for the debtor. Justices Ginsburg, Alito, and the Chief Justice all found it quite odd that Congress would have allowed a debtor who had not herself saved the money for retirement to keep such a huge pile of money for herself, ripe for immediate enjoyment. Why Congress would have wanted a debtor to be able to keep all of an inherited IRA, but none of other inherited funds, puzzled them.
Yet, the questioning suggested that a majority of the Justices — led most vociferously by Justice Breyer — found the statutory reading to favor the debtor. The relevant statutory exemption language is for “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under” certain enumerated sections of the Internal Revenue Code, including the ones for IRAs. The inherited funds indisputably satisfied the latter part of the statutory test, as they were exempt from taxation under a listed section. The battle is over whether they are “retirement funds” within the meaning of the exemption. The debtor argued that they are, as they had that status when set aside initially in the account by the debtor’s mother, and nothing in the statute limited the exemption to “the debtor’s” retirement funds. The trustee countered by arguing that after being inherited, in the hands of the non-spousal debtor, they no longer constituted retirement funds at all. While still tax exempt, the attributes relevant to retirement had changed significantly so as to negate that characterization; for example, the debtor could withdraw the money immediately (before age 59½), and indeed was not even permitted to wait until she was 59½, but had to start withdrawals within a short time. Also, she could neither make new retirement contributions to the fund nor roll it over.
The Justices, though, seemed persuaded by the plain meaning of the unqualified reference to “retirement funds,” especially given the telling omission of any further requirement that they be “the debtor’s” retirement funds. This omission was notable, the Justices thought, since all of the other enumerated exemption provisions in section 522(d) do include a specific reference to “the debtor’s” interest in the property at issue, be it a car, a tool of the trade, a homestead, or whatever. The Justices also seemed to agree with the debtor that the qualifying language “to the extent” in the exemption favored a broader reading of the “retirement funds” language. Further, the Court worried about the administrative complexity that would result if “retirement funds” was not given a broad meaning. In short, several of the Justices thought that the phrase “retirement funds” was not necessarily and definitionally limited to funds set aside originally by the debtor (or inherited only by a spouse), but could include a retirement fund that was inherited from its creator by someone other than a spouse.
Economically and demographically, this is a huge issue. Massive amounts of wealth are being passed down to future generations via inherited retirement vehicles as both “the greatest generation” and baby boomers are dying. Whether creditors get to share in that largesse or not is a very significant question; the magnitude is staggering. Forty percent of U.S households have IRAs, totaling over $5 trillion in value. Indisputably, in the hands of the person who set up the IRA, creditors cannot touch the money in bankruptcy. Is that protection lost if the creator of the IRA dies and the funds are inherited by someone other than her spouse? When the Court hands down its decision in Clark v. Rameker, we will know the answer. After the oral arguments, it appears likely that the Court will hold for the debtor and maintain the exemption; in short, the exempt status of “retirement funds” in bankruptcy will not die with the creator of the account.
Looking for a transcript of yesterday's oral argument? Please click here: http://www.supremecourt.gov/oral_arguments/argument_transcripts/13-299_…