Are they or aren't they "retirement funds"? The case for including funds from an inherited IRA in a debtor's bankruptcy estate: Clark v. Rameker.

Author:Salisbury, Jennifer
Position:Individual retirement account
 
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  1. INTRODUCTION

    Individual Retirement Accounts ("IRAs") (1) are booming. As of mid-2013, an estimated 46 million--more than three out of every ten--U.S. households owned at least one type of IRA. (2) As of the end of 2013, IRA assets totaled $6.5 trillion, accounting for 28% of U.S. retirement assets. (3) While IRA investments are increasing in popularity, there were still over 1 million bankruptcy filings in the United States in 2013. (4) Of those, 728,833 (68%) were non-business debtors filing for Chapter 7 bankruptcy. (5)

    When a debtor files for Chapter 7 bankruptcy (6) in the United States, a bankruptcy estate is created by operation of law. (7) Once the estate is created, the Bankruptcy Code establishes what property and funds of the debtor are includable in the estate and what property may be excluded. (8) However, determining which property and funds can be included in the estate does not end the inquiry. Some property and funds that are included may still be exempted from the estate (9) for the debtor's fresh start. (10)

    A bankruptcy estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." (11) However, there are some retirement funds that may be excluded from the bankruptcy estate, including: qualified education IRAs, (12) qualified employee benefit plans, (13) qualified deferred compensation plans, (14) and qualified tax-deferred annuities. (15) Further, of those retirement funds that are included in a debtor's bankruptcy estate, there are seven types of retirement funds that may then be exempted out of the estate to contribute to the debtor's fresh start. (16) Those funds include: (1) qualified pension, profit sharing, or stock bonus plans; (17) (2) qualified annuity plans; (18) (3) IRAs; (19) (4) Roth IRAs; (20) (5) retirement plans for defined controlled groups of employees; (21) (6) deferred compensation plans of state and local governments and tax-exempt organizations; (22) and (7) retirement plans established and maintained by defined tax-exempt or government organizations. (23)

    In 2014, the Supreme Court of the United States decided the case of Clark v. Rameker, where it faced the undecided issue of whether an IRA inherited by a debtor prior to filing for bankruptcy may be exempted from the debtor's bankruptcy estate as part of her fresh start. (24) In reaching its decision in Clark, the Court addressed Bankruptcy Code Section 522(b)(3)(C), (25) which exempts from a bankruptcy estate a debtor's retirement funds, including those in a traditional or Roth IRA. (26) At issue in Clark was the potential exemption of an inherited IRA from a bankruptcy estate. (27)

    This Note first discusses the subsequent history of Clark. Next, it discusses the legal history of both non-inherited and inherited IRAs leading up to the Clark decision. Then, it details the Court's decision in Clark. Finally, it concludes with a comparison of state and federal exemption schemes, using Missouri as an example, calling for reform of Bankruptcy Code Section 522(b)(3).

  2. FACTS AND HOLDING

    In 2001, Heidi Heffron-Clark inherited a traditional IRA from her mother, Ruth Heffron, upon her death. (28) Heffron had established the traditional IRA one year prior, in 2000, naming Heffron-Clark as the sole beneficiary. (29) At the time of inheritance, the IRA was worth just over $450,000. (30) Upon inheritance, Heffron's traditional IRA became an inherited IRA in Heffron- Clark's name, and Heffron-Clark chose to take monthly distributions from the account. (31)

    In October of 2010, Heffron-Clark and her husband ("Petitioners") filed a Chapter 7 bankruptcy petition, identifying the inherited IRA as exempt from the bankruptcy estate under U.S.C. [section] 522(b)(3)(C). (32) At the time of the bankruptcy filing, the IRA's value had decreased to approximately $300,000. (33) The Chapter 7 bankruptcy trustee for the estate, Rameker, and unsecured creditors of the estate claimed that the funds from the inherited IRA were not exempt from bankruptcy because they "were not 'retirement funds' within the meaning of the statute." (34) In December of 2010, Rameker filed an objection to exemption in the U.S. Bankruptcy Court for the Western District of Wisconsin, claiming that the funds from the inherited IRA were non-exempt property of the bankruptcy estate. (35)

    A hearing in bankruptcy court was held in February of 2011, and the parties agreed to submit the matter on briefs. (36) Petitioners claimed that the funds from the inherited IRA were exempt under both Wisconsin Statute Section 815.18(3)(j) (37) and Bankruptcy Code Section 522(b)(3)(C). (38) Rameker argued that the funds did not qualify as "retirement funds" because Heffron- Clark could not make any contributions to the inherited IRA, the funds were not required to be held until retirement without a tax penalty, and Heffron- Clark could take distributions as she pleased with no tax implications. (39) Petitioners countered by arguing that because the inherited IRA was once referred to as a "retirement account," the funds remaining were still "retirement funds." (40) They also argued that the plain meaning of Section 522(b)(3)(C) did not specify that "retirement funds" include only funds set aside for a designated person's retirement; instead, the statute requires only that the funds be set aside for some person's retirement. (41)

    Because the Bankruptcy Code does not define the term "retirement funds," the bankruptcy court had to determine whether the funds from the inherited IRA did in fact constitute "retirement funds." (42) The court deferred to the "common or ordinary meaning" of "retirement fund," and stated that Webster's Ninth New Collegiate Dictionary defined "retirement" as the "withdrawal from one's position or occupation or from active working life." (43) Thus, the court stated that in order for funds to qualify as "retirement funds" under the statute, the funds "must be held in anticipation of 'withdrawal from one's position or occupation.'" (44)

    Deciding against a leading case from the U.S. Court of Appeals for the Eighth Circuit, In re Nessa, (45) the bankruptcy court reasoned that the inherited IRA did not contain any person's "retirement funds" because the funds were no longer being held in anticipation of any person's retirement. (46) Further, the court reasoned that Congress did not intend for inherited IRAs to be characterized as "retirement funds." (47) The court used examples to illustrate its reasoning: the owner of an inherited IRA cannot contribute any additional funds to the account, cannot roll the funds into her own IRA, and "must begin taking monthly distributions immediately, regardless of age or employment status, from the account in accordance with the IRS distribution guidelines." (48) In direct contrast, a holder of an IRA "can make tax deferred contributions to their account for purposes of saving for their retirement," and he or she "cannot withdraw, without penalty, funds from their account prior to a designated retirement age." (49) The bankruptcy court ultimately held that funds in an inherited IRA did not qualify as retirement funds, and thus were not exempt from a bankruptcy estate. (50)

    In 2012, Petitioners filed an appeal with the U.S. District Court for the Western District of Wisconsin. (51) The district court quickly pointed out that the bankruptcy court's ruling was very much a minority opinion, as it was consistent with just one other case. (52) All other cases, including the leading Eighth Circuit case, Nessa, ruled that funds in an inherited IRA were "retirement funds." (53) The reasoning behind those cases was that "retirement funds" need only to have been "accumulated for retirement purposes originally." (54) In deciding the case at hand, the district court agreed with the majority view of the Eighth Circuit, holding that the retirement fund exception does not distinguish between a retirement fund earned by Heffron-Clark herself and a retirement fund inherited by Heffron-Clark, and thus the funds in the inherited IRA are "retirement funds." (55) The district court reversed and remanded the bankruptcy court's decision. (56)

    In 2013, the U.S. Court of Appeals for the Seventh Circuit heard the case on appeal. (57) The Seventh Circuit agreed with the bankruptcy court and followed the same reasoning, finding that because inherited IRAs do not have the same qualifications and characteristics as IRAs, they do not qualify as "retirement funds." (58) Thus, the Seventh Circuit reversed the district court's decision, agreeing with the outcome of the bankruptcy court. (59)

    In 2014, upon a grant of certiorari, (60) the Supreme Court of the United States heard the instant case. (61) The unanimous Court affirmed the Seventh Circuit's decision, holding that the funds in the inherited IRA were not "retirement funds" within the meaning of the statute. (62)

  3. LEGAL BACKGROUND

    The path to Clark v. Rameker has taken twenty-two years, and the one constant along the way has been the discussion of retirement funds held in IRAs. In 1992, in Patterson v. Shumate, the Supreme Court of the United States held that Employee Retirement Income Security Act ("ERISA") funds are excluded from a debtor's bankruptcy estate under Bankruptcy Code Section 541(c)(2). (63) Then, in 2005, in Rousey v. Jacoway, the Court held that IRAs are exempt from a debtor's bankruptcy estate under Section 522(d)(10)(E). (64) Later in 2005, Congress passed legislation that specifically exempted IRAs from a bankruptcy estate. (65) However, none of these decisions addressed inherited IRAs. Consequently, the determination of whether inherited IRAs may be exempted from a bankruptcy estate has been left to the states and lower courts.

    1. What Is an IRA?

      IRA is an initialism for "individual retirement account." (66) Investing in an IRA is one way to save for retirement, and there are tax benefits afforded to the owner in that her gain is...

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