Inherited IRA not automatically exempt

We commonly say that an IRA is exempt in a bankruptcy, up to $1,000,000.00 of value.  However the US Supreme Court has ruled that this general statement is not correct in the case of an inherited IRA. The citation is:  Clark v. Rameker, 134 S. Ct. 2242, 189 L. Ed. 2d 157 (2014).  In that case the Court said:  “[t]he text and purpose of the Bankruptcy Code make clear that funds held in inherited IRAs are not ‘retirement funds’ within the meaning of §522(b)(3)(C)’s bankruptcy exemption."

The facts of the case are that Mrs. Clark's mother set up an IRA in 2000 and named her daughter as the beneficiary of the IRA.  The mother died shortly thereafter, and the account passed to her daughter.  About nine years after that the daughter filed chapter 7 bankruptcy.  The account was worth about $300,000.00 at that time.

Mrs. Heffron-Clark claimed the IRA as exempt under 11 U.S.C. Sec. 522(b)(3). The trustee objected to the claimed exemption, arguing that the money in an inherited IRA is not "retirement funds" and therefore not exempt.

The Supreme Court opinion first noted that "Inherited IRAs do not operate like ordinary IRAs. Unlike with a traditional or Roth IRA, an individual may withdraw funds from an inherited IRA at any time, without paying a tax penalty."

The Court then said:  "Three legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objectively set aside for the purpose of retirement. First, the holder of an inherited IRA may never invest additional money in the account.... Second, holders of inherited IRAs are required to withdraw money from such accounts, no matter how many years they may be from retirement....Finally, the holder of an inherited IRA may withdraw the entire balance of the account at any time — and for any purpose — without penalty."

Ruling against Mrs. Clark, Justice Sotomayor said:  "For if an individual is allowed to exempt an inherited IRA from her bankruptcy estate, nothing about the inherited IRA's legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete. Allowing that kind of exemption would convert the Bankruptcy Code's purposes of preserving debtors' ability to meet their basic needs and ensuring that they have a "fresh start,"Rousey, 544 U. S., at 325, into a "free pass," Schwab, 560 U. S., at 791"

Fortunately, this is a pretty limited decision, for most people will set up their own IRA, not inherit one.  However, I mention it as it is yet another example in which there is an important exception to the general rule.