Can an IRA (individual retirement account) inherited from a relative be exempted by a debtor in bankruptcy? No, says a recent Kansas bankruptcy judge’s decision. The case was In Re Mosby (14-22981), decided in June 2015 by Judge Dale Somers. The facts were interesting.
The debtor filed a voluntary petition under Chapter 7 on December 29, 2014. The debtor claimed Jackson Life IRA valued at $15,015.50 as exempt under various Kansas statutes, including K.S.A. 60-2308, 60-2308(b), and 60-2313(a)(1).
The statute that the Debtor relied on ( K.S.A. 2014 Supp. 60-2308(b)) stated the following:
(b) Except as provided in subsection (c), any money or other assets payable to a participant or beneficiary from, or any interest of any participant or beneficiary in, a retirement plan which is qualified under Sections 401(a), 403(a), 403(b), 408, 408A or 409 of the federal internal revenue code of 1986, and amendments thereto, shall be exempt from any and all claims of creditors of the beneficiary or participant. Any such plan shall be conclusively presumed to be a spendthrift trust under these statutes and the common law of the state.
Debtor inherited the Jackson Life IRA from her mother, and it was an inherited IRA as defined by 26 U.S.C. § 408(d)(3)(C)(ii). The Chapter 7 Trustee did not agree that the inherited IRA was an exempt IRA (such as a traditional IRA or Roth IRA). The Trustee saw it more as an inheritance.
The Trustee cited the case of Clark v. Rameker, ___ U.S. ___, 134 S.Ct. 2242, 189 L.Ed.2d 157 (2014), where the United States Supreme Court held that funds in an IRA which a Chapter 7 debtor inherited from her late mother were not “retirement funds,” as that phrase is used in the federal bankruptcy exemption, 11 U.S.C. § 522(b)(3)(C). Debtor responded by saying that the Kansas exemption statute is more broad, and that it should control.
In the Clark case, cited above, the Supreme Court pointed out how inherited IRAs were not like ordinary IRAs. The Court said:
Inherited IRAs do not operate like ordinary IRAs. Unlike with a traditional . . . IRA, an individual may withdraw funds from an inherited IRA at any time, without paying a tax penalty. Indeed, the owner of an inherited IRA not only may but must withdraw its funds: The owner must either withdraw the entire balance in the account within five years of the original owner’s death or take minimum distributions on an annual basis. And unlike with a traditional . . . IRA, the owner of an inherited IRA may never make contributions to the account.
So, according to the Court, there are three basic legal features of an inherited IRA. First, contributions to inherited IRAs are forbidden. Second, “holders of inherited IRAs are required to withdraw money from such accounts, no matter how many years they may be from retirement.” And third, the holder of an inherited IRA may withdraw the entire balance, without penalty at any time. Clearly, inherited IRAs are more like bequests than true retirement accounts.
The debtor tried to argue that her inherited Jackson Life IRA was defined by 26 U.S.C. § 408, one of the federal statutes enumerated in the Kansas retirement funds exemption statute. But the court found that this was irrelevant. “The Kansas statute does not say that all accounts defined by § 408 constitute retirement plans. Examination of the legal characteristics of IRAs leads to the conclusion that IRAs constitute retirement plans but inherited IRAs do not”, the Court stated.
Because the inherited IRA looked more like a cash asset given to a debtor than a real IRA that had been funded by a debtor, the Court found that it could not be exempted, and it sustained the Trustee’s objection.
Since this was a Chapter 7 case, the asset would normally have to be turned over to the Trustee for distribution to the creditors. However, the debtor still may have been able to take some steps to keep the asset. She could have converted her case to a Chapter 13 case and offered to pay into the plan the value of the asset over the duration of the proposed plan. Or, she could have filed a motion with the Court to keep the asset, assuming that there was valid argument to do so.