In Clark v. Rameker, the United States Supreme Court held that an inherited IRA does not fall within the definition of retirement funds under Federal Bankruptcy law and is, therefore, not exempt from claims in a bankruptcy proceeding. This decision had a considerable impact upon the estate planning world.
It has long been the law that IRA or other retirement accounts, as defined in 11 U.S.C. § 522(b)(3)(C) are exempt from the reach of a bankruptcy trustee. In the Clark decision, the Court was called upon to decide whether funds contained an inherited Individual Retirement Account (“IRA”) qualify as retirement funds “within the meaning of the bankruptcy exemption”. The Court found that an inherited IRA does not qualify for the bankruptcy exemption. In making its decision, the Court identified three independent characteristics which differentiate an IRA from an inherited IRA. Unlike traditional IRAs or Roth IRAs, where one can make an additional contribution to the IRA, the owner/beneficiary of an inherited IRA may never invest additional money in the account. Secondly, an individual owner of an inherited IRA is required to make mandatory required distributions from the account annually beginning in the year after the deceased owner’s death, based upon the life expectancy of the individual who has inherited the IRA account. This is in direct contrast to the owner of a traditional IRA who must withdraw funds without penalty only when he or she is close to retirement age, i.e. age 59 ½. Thirdly, the Court noted that one who has inherited an IRA account may withdraw the entire balance at any time and for any purpose without penalty. The owner of a traditional IRA or other retirement account will pay a ten percent (10%) penalty, subject to some very narrow exceptions, if he withdraws prior to age 59 ½. For these reasons, the Court held that an inherited IRA may not benefit from the protection afforded to the owner or participant in a traditional retirement account.
Interestingly, in New Jersey, however, it has been determined that an inherited IRA constitutes a “qualifying trust” under N.J.S.A. 25:2-1(b) and as such will be excluded from a debtor’s bankruptcy estate. In Re: Andolino, 525B.R.588. The New Jersey Bankruptcy Court found that the language of the New Jersey Statutes exempts the inherited IRA from the bankrupt’s estate. In that regard, N.J.S.A. § 25:2-1(b) provides that “any property held in a qualifying trust and any distributions from a qualifying trust, regardless of the distribution plan elected for the qualified trust, shall be exempt from all claims of creditors and shall be excluded from the estate in bankruptcy”. Id. A “qualifying trust” refers to a trust “created or qualified and maintained pursuant to Federal law, including but not limited to § 408 of the Internal Revenue Code of 1986. The Bankruptcy Court in New Jersey noted that the IRA’s “status as a qualifying trust remains unchanged, notwithstanding the debtor’s receipt of the IRA as a beneficiary”. Andolino supra, at 591.