Supreme Court Rules That Inherited IRAs Are Not Protected in Bankruptcy

06.20.2014

In a ruling which caught more than a few bankruptcy practitioners by surprise, the U.S. Supreme Court ruled on June 12, 2014, that Individual Retirement Accounts that are inherited are not protected in personal bankruptcy cases.  The case, Clark v. Rameker, resolved a split among the Circuit Courts and followed the Seventh Circuit Court of Appeals.  The debtor in the case had inherited her mother’s IRA account and then filed a Chapter 7 bankruptcy case a few years later.  At the time of bankruptcy filing, the IRA value was roughly $300,000. 

IRAs and other retirement accounts have long been protected (or “exempt”) in bankruptcy cases but, in Clark v. Rameker, Justice Sotomayor noted that an inherited IRA does not act like a traditional IRA.  An individual may withdraw funds, penalty-free, from an inherited IRA at any time and is not allowed to make ongoing contributions to an inherited IRA.  The Court noted that in protecting traditional IRAs, the Bankruptcy Code strikes a delicate balance between the interests of debtors (protecting essential needs and allowing a fresh start) and creditors, but found that policy or purpose lacking with respect to inherited IRAs.  The Court envisioned a situation where a debtor could file bankruptcy, exempt a substantial inherited IRA and then, right after bankruptcy, use the funds for an extravagant purchase, with no penalty.  The Court opined that an inherited IRA looked more like a pot of money to pay creditors than retirement savings.  As such, the Court found that the IRA was not protected.  Not being protected, the asset could be liquidated by the bankruptcy trustee and used to pay creditor claims.