Gifting Your “Retirement Account” to Another Person? Be Careful.

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Heidi Heffron-Clark inherited her mother’s IRA worth approximately $300,000. Her mother’s account passed to Heidi after her mother’s death. The IRA remains sheltered from taxation until the money is withdrawn, but many of the account’s other attributes changed. For example, the account would still be tax-deferred for a short period of time, but payout of the assets would need to begin within a year of the original owner’s death.

As a result of these changes in the character of an inherited IRA, the federal appeals court in Chicago has decided, such “retirement funds” are no longer be exempt from the claims of creditors. [FN1] The Seventh Circuit Court of Appeals considered this question in the context of Heidi and her spouse’s bankruptcy case in Wisconsin, which permit the use of federal exemption statutes for retirement funds.*

The Wisconsin bankruptcy court had held that an inherited IRA does not represent “retirement funds” in the hands of the current owner and so is not exempt under Bankruptcy Code Sections 522(b)(3)(C) and (d)(12). [FN2] The bankruptcy judge concluded that money counts as “retirement funds” only when held for the owner’s retirement, while an inherited IRA must be distributed earlier.

The Wisconsin federal district judge reversed, adopting the view first articulated by the Bankruptcy Appellate Panel for the Eighth Circuit. In the Eighth Circuit BAP’s view, any money representing “retirement funds” in the decedent’s hands must be treated the same way in the successors’ hands. [FN3] The Fifth Circuit has since followed that approach, observing that the Bankruptcy Code refers to “retirement funds” without providing that they must be the debtor’s. [FN4]

Departing from the views of courts of the two sister federal appeals circuits, the Seventh Circuit did not see this as a close question. It saw the inheritance of the IRA as akin to a cash withdrawal of the IRA by the mother, who then gave it to her daughter. Just because the IRA had at one time been retirement funds did not mean that they were still retirement funds in the hands of the new owner. Key to the decision was the new economic attributes of the asset and how they function in the hands of the debtor. In this case, it found that inherited IRA represented an opportunity for current consumption, not continued retirement savings. [FN5]

Even under state exemption statutes which provide exemptions for retirement funds, the ruling that a retirement fund changes in its exempt character upon being inherited by a new owner is significant. In Illinois, debtors may claim an exemption for retirement plans as exempt from the claims of creditors, which include IRAs. [FN6] Under the reasoning of the Seventh Circuit, retirement funds inherited from another person may no longer fall into this category.

[FN1] In re Clark, 714 F.3d 559, 2013 WL 1729600, No. 12-1241, 12-1255 (7th Cir. April 23, 2013)aff’d Clark v. Rameker, 134 S.Ct. 678, 187 L.Ed.2d 544, 82 USLW 3324, 82 USLW 3328 (U.S. Nov 26, 2013) (NO. 13-299, 13A147).

*The decision of the Seventh Circuit was subsequently affirmed by the U.S. Supreme Court in a unanimous decision.

[FN2] Clark, supra FN1 at 3, citing 450 B.R. 858 (Bankr. W.D. Wis. 2011).

[FN3] Clark, supra FN1 at 3-4, citing 466 B.R. 135 (W.D. Wis. 2012) and In re Nessa, 426 B.R. 312 (BAP 8th Cir. 2010).

[FN4] Clark, supra FN1 at 4, citing In re Chilton, 674 F.3d 486 (5th Cir. 2012).

[FN5] Clark, supra FN1 at 4-8.

[FN6] See e.g. 735 ILCS 12-1006.


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