The Supreme Court’s decision in Clark v. Rameker, 573 U.S. 122 (2014), does not mean that all inherited IRAs are not exempt. As explained by Chief Bankruptcy Judge Thad J. Collins of Cedar Rapids, Iowa, some inherited IRAs can be exempt.
Specifically, a surviving spouse is entitled to exempt an inherited IRA if the surviving spouse elects to roll over the inherited IRA into a traditional IRA or a Roth IRA.
No State Exemption for the Inherited IRA
The debtor’s husband died in 2008. The debtor at that time rolled over her deceased husband’s IRA into her own IRA. She had contributed nothing to her husband’s IRA. Her husband or his employer made all of the contributions.
The surviving wife filed a chapter 7 petition in 2022 and claimed an exemption in the inherited IRA. The trustee objected, citing Clark and saying that an inherited IRA is not exempt under Iowa law.
Judge Collins overruled the objection and allowed the exemption in an opinion on April 11.
The Federal Exemption Applied
Iowa only allows its bankrupt citizens to take state exemptions. The debtor therefore could not claim an exemption for “retirement funds” in Section 522(d)(11). Under Iowa law, inherited IRAs are not exempt, seeming to leave the debtor with no ability to retain the inherited IRA.
No so, Judge Collins said, citing Section 522(b)(1) and (b)(3).
With federal exemptions unavailable, Judge Collins said that the debtor was limited to exemptions provided in Section 522(b)(3). Subsection (b)(3)(C) allows exemptions for “retirement funds” that are exempt from taxation under specified provisions of the IRS Code.
Judge Collins cited and quoted In re Pacheco, 537 B.R. 935, 939 (Bankr. D. Ariz. 2015), where Chief Bankruptcy Judge Eddward P. Ballinger, Jr., said,
The exemption under § 522(b)(3)(C) is available to all debtors regardless of whether the debtor’s particular state has opted out of the federal exemption scheme of § 522(d) . . . . The addition of 522(b)(3)(C) was intended to expand the protection granted to retirement plans in bankruptcy that may not have been already protected under state or federal law.
Next, Judge Collins analyzed whether the inherited IRA qualified as “retirement funds” under Section 522(b)(3)(C).
In Clark, the Supreme Court held that inherited IRAs are not exempt. Judge Collins explained that the opinion gave the surviving spouse an election between (1) rolling over the inherited IRA subject to tax and bankruptcy rules for traditional IRAs or Roth IRAs, or (2) keeping the inherited IRA as an inherited IRA subject to different tax and bankruptcy rules for inherited IRAs.
In the case at hand, Judge Collins said that the debtor had rolled over the inherited IRA into the IRA she claimed as exempt. As a consequence, he said that the “Debtor’s IRAs are retirement accounts . . . [that] are subject to the same tax and bankruptcy rules as would apply to funds that Debtor had contributed herself.”
Judge Collins held that the “Debtor therefore properly claimed exemption of the funds in her IRAs.”
Observations
Someone with an IRA inherited from a deceased spouse may be better off in bankruptcy than not in bankruptcy. In Iowa, for instance, the rolled-over IRA would not be exempt for someone not in bankruptcy.
We have been told that some other states amended their exemptions after Clark to cover inherited IRAs.
Counsel in states that don’t exempt inherited IRAs should consider lobbying the legislature to expand the exemption to cover inherited IRAs, especially because the prospect of losing an inherited IRA could force a surviving spouse into an otherwise unnecessary bankruptcy.
The Supreme Court’s decision in Clark v. Rameker, 573 U.S. 122 (2014), does not mean that all inherited IRAs are not exempt. As explained by Chief Bankruptcy Judge Thad J. Collins of Cedar Rapids, Iowa, some inherited IRAs can be exempt.
Specifically, a surviving spouse is entitled to exempt an inherited IRA if the surviving spouse elects to roll over the inherited IRA into a traditional IRA or a Roth IRA.