Retirement accounts that a debtor received in a marital property settlement are not exempt in bankruptcy, according to an October 16 opinion by the Eighth Circuit Bankruptcy Appellate Panel. The case involved an individual retirement account and a 401(k) belonging to the debtor’s wife that he was to receive in a divorce proceeding.
By extension, the principle stated by the BAP would seem to mean that a retirement account inherited from a deceased spouse likewise would not be exempt. Deceased or divorced, the decision cuts against nonworking spouses who end up in bankruptcy.
The appeal turned on Clark v. Rameker, 134 S. Ct. 2242 (2014), where the Supreme Court ruled that a retirement account inherited from the debtor’s mother was not exempt under Section 522(b)(3)(C). That section exempts “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation'' under specified provisions in the Internal Revenue Code.
Writing for the high court, Justice Sotomayor employed what she called an “objective” analysis of “legal characteristics” of an individual retirement account, not whether the bankrupt individual planned to use the IRA for retirement. Saying that the court must analyze the “text and purpose” of the exemption statute, she held that the inherited IRA was not exempt, even though it fell within the enumerated sections of the tax code listed in Section 522(b)(3)(C).
Writing for the BAP, Bankruptcy Judge Anita L. Shodeen of Des Moines, Iowa, quoted Justice Sotomayor as saying that the term “retirement funds,” which is not defined in the Bankruptcy Code, is “properly understood to mean sums of money set aside for the day an individual stops working.” Id., 134 S. Ct. at 2246.
From that statement, Judge Shodeen said that Clark “clearly suggests that the exemption is limited to individuals who create and contribute funds into the retirement account. Retirement funds obtained or received by any other means do not meet this definition.” [Emphasis added.]
The debtor argued that the IRA represented marital property set aside by his former wife for their joint retirement. Rejecting the argument, Judge Shodeen again quoted from Clark, where Justice Sotomayor said that the court should “look to the legal characteristics of the account in which the funds are held, asking whether, as an objective matter, the account is one set aside for the day when an individual stops working.”
Judge Shodeen said she “recognized” that the debtor’s interest in the retirement accounts “did not arise in the identical manner as the IRA account addressed in Clark.” However, she said the “distinction is not material to our de novo review. Any interest he holds in the accounts resulted from nothing more than a property settlement.” [Emphasis added.]
Employing the “reasoning of Clark,” Judge Shodeen upheld the bankruptcy court and ruled that the retirement accounts were not exempt under federal law.
Observation: The holding by the BAP means that a bankrupt nonworking spouse will have nothing after divorce aside from maintenance or support and whatever individual property he or she has that happens to be exempt. If the divorce settlement was structured to transfer retirement accounts in lieu of maintenance or support, bankruptcy could leave a nonworking spouse with nothing at all.
The BAP’s holding would presumably also apply to a retirement account that a debtor inherited from a deceased spouse. Indeed, it would not matter how long the spouse’s death preceded bankruptcy.
Take the case of a nonworking spouse who ends up in bankruptcy. He or she might have little aside from Social Security and the deceased or former spouse’s retirement accounts to provide income. The BAP opinion means that retirement accounts in both situations would not be exempt. The result could leave a nonworking spouse with little aside from his or her Social Security, which might be minimal.
Judge Shodeen saw no significance in the factual distinction between Clark and the case on appeal. In Clark, the debtor inherited an IRA from the debtor’s mother. In future cases, or on appeal to the Eighth Circuit, the debtor might explore the nature of an interest that someone has under state law in a spouse’s retirement account.
It may be that the debtor’s interest is different if a retirement account was held by a spouse than if the retirement account was held by a non-spouse relative. A spouse may have an inchoate interest in a husband or wife’s IRA that does not exist with respect to an inheritance from a non-spouse. It may also matter if the state is a community property state. But should the result under federal law differ if the state is or is not a community property state?
The BAP’s decision may very well be the correct or prevailing interpretation of the statute. If it is, this writer suggests that Congress should revisit the issue.
Bankruptcy Appellate Panel Holds that an IRA from a Marital Property Settlement Is Not Exempt
Retirement accounts that a debtor received in a marital property settlement are not exempt in bankruptcy, according to an October 16 opinion by the Eighth Circuit Bankruptcy Appellate Panel. The case involved an individual retirement account and a 401k belonging to the debtor’s wife that he was to receive in a divorce proceeding.
By extension, the principle stated by the Bankruptcy Appellate Panel would seem to mean that a retirement account inherited from a deceased spouse likewise would not be exempt. Deceased or divorced, the decision cuts against nonworking spouses who end up in bankruptcy.