In Clark v. Rameker, 573 U.S. 122 (2014), the Supreme Court held that individual retirement accounts inherited before bankruptcy are not exempt and belong to creditors. It follows, does it not, that a debtor cannot keep a 401(k) inherited before bankruptcy?
Answer: Wrong. Unlike an IRA, an inherited 401(k) does not become estate property, for reasons explained by Bankruptcy Judge George R. Hodges of Asheville, N.C.
The Inherited IRA
Not long before filing a chapter 7 petition, the debtor inherited a 401(k) from someone who was neither her spouse nor a relative. The debtor told the trustee about the inherited 401(k) but did not list it among her assets, nor did she claim an exemption. Rather, the debtor took the position that the 401(k) was not estate property, thus making exemptions and scheduling irrelevant.
Disagreeing, the trustee filed a turnover motion, relying largely on Clark, where the Supreme Court held that an inherited IRA is not exempt under Section 522(b)(3)(C) because it doesn’t fit the description of “retirement funds.”
In his June 4 opinion, Judge Hodges concluded that an inherited 401(k), unlike an inherited IRA, never becomes estate property. He wasn’t required to decide whether an inherited 401(k) is an exempt asset, the focus of Clark.
Clark Distinguished
Judge Hodges distinguished Clark. There, the question was whether an inherited IRA fell under Section 522(b)(3)(C), which exempts “retirement funds” if they are exempt from taxation under specified provisions of the Internal Revenue Code.
Clark focused on the characteristics of inherited IRAs that make them something other than “retirement funds.” Unlike retirement funds, the holder of an IRA cannot make additional investments, must continually make withdrawals, and may withdraw everything without incurring a penalty.
Judge Hodges observed that inherited 401(k)s have “the same legal characteristics,” but the result was not the same.
Unlike IRAs, the trusts holding 401(k)s must have anti-alienation provisions as required by both the IRS Code and ERISA.
The anti-alienation provisions in 401(k) trusts invoke Section 541(c)(2), which provides that “a restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” Property in a trust that complies with Section 541(c)(2) does not become estate property.
Judge Hodges held that the outcome was not controlled by Clark, but by Section 541(c)(2) and Patterson v. Shumate, 504 U.S. 753 (1992). In Patterson, the Supreme Court held that “applicable nonbankruptcy law” includes ERISA-qualified plans. Id. at 759.
IRAs, Judge Hodges said, “are not qualified plans under ERISA.” By way of contrast, “a 401(k) plan is a qualified plan under ERISA and qualifies for tax benefits and protection that an IRA does not.”
To qualify under ERISA, the trust for a 401(k) must provide that it “may not be assigned or alienated.” For tax benefits, the IRS Code also requires that assets in a 401(k) may not be assigned or alienated.
Judge Hodges therefore concluded that “401(k) plans contain enforceable transfer restrictions for purposes of § 541(c)(2)’s exclusion of property from the bankruptcy estate.”
Furthermore, Judge Hodges mentioned how the “Supreme Court in Patterson even acknowledge[d] that ERISA-qualified plans receive greater protection than IRAs in bankruptcy,” because IRAs are not included in ERISA’s anti-alienation provision.
Judge Hodges noted that Section 541(c)(2) does not mention “retirement funds” like Section 522(b)(3)(C), the focus of Clark. Thus, he said, “the legal characteristics of inherited IRAs relevant to the Supreme Court’s analysis in Clark are not relevant to the analysis of 401(k)’s.”
In the case before Judge Hodges, the funds had not been withdrawn from the 401(k) before bankruptcy, meaning that they were protected by the trust’s anti-alienation provisions. He therefore held that the funds in the 401(k) “are not property of the estate” under Section 541(c)(2) and belong to the debtor. The lack of an exemption didn’t matter because exemptions only apply to estate property.
In Clark v. Rameker, 573 U.S. 122 (2014), the Supreme Court held that individual retirement accounts inherited before bankruptcy are not exempt and belong to creditors. It follows, does it not, that a debtor cannot keep a 401(k) inherited before bankruptcy?
Answer: Wrong. Unlike an IRA, an inherited 401(k) does not become estate property, for reasons explained by Bankruptcy Judge George R. Hodges of Asheville, N.C.
The Inherited IRA
Not long before filing a chapter 7 petition, the debtor inherited a 401(k) from someone who was neither her spouse nor a relative. The debtor told the trustee about the inherited 401(k) but did not list it among her assets, nor did she claim an exemption. Rather, the debtor took the position that the 401(k) was not estate property, thus making exemptions and scheduling irrelevant.
Disagreeing, the trustee filed a turnover motion, relying largely on Clark, where the Supreme Court held that an inherited IRA is not exempt under Section 522(b)(3)(C) because it doesn’t fit the description of “retirement funds.”
In his June 4 opinion, Judge Hodges concluded that an inherited 401(k), unlike an inherited IRA, never becomes estate property. He wasn’t required to decide whether an inherited 401(k) is an exempt asset, the focus of Clark.