Inherited IRAs do not qualify for bankruptcy exemption, Seventh Circuit holds

A debtor’s inherited IRA does not qualify for the bankruptcy exemption provided in sections 522(b)(3)(C) and (d)(12) of the U.S. Bankruptcy Code, the U.S. Court of Appeals in Chicago (CA-7) has held.

Note: The Seventh Circuit’s conclusion creates a conflict among the circuits.

At the time of her death, the decedent owned an IRA worth about $300,000. Her daughter was the designated beneficiary. Subsequently, a bankruptcy proceeding was initiated by the daughter and her husband.

Sections 522(b)(3)(C) and (d)(12) of the Bankruptcy Code exempt from creditors’ claims any “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under Sections 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code.” The bankruptcy court ruled that an inherited IRA does not represent “retirement funds” in the hands of the current owner and therefore is not exempt under sections 522(b)(3)(C) and (d)(12) of the Bankruptcy Code.

The federal district court reversed, holding that any money representing “retirement funds” in the hands of the decedent must be treated the same way as in the hands of the beneficiary. This view is in accord with the holding of the Fifth Circuit in In the Matter of Chilton.

The Seventh Circuit disagreed. The bankruptcy exemption provided in sections 522(b)(3)(C) and (d)(12) of the Bankruptcy Code “provides a specific exemption for retirement funds – and inherited IRAs do not qualify because they are not savings reserved for use after their owners stop working,” the court stated.

The appellate court noted that the district court judge thought the question “close” and believed that close questions should be decided in the debtors’ favor. “We do not think the question close,” the appeals court said. Inherited IRAs “represent an opportunity for current consumption, not a fund of retirement savings,” the court held. Accordingly, the holding of the district court was reversed.

Source: In the Matter of Clark (CA-7).

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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