Circuit Split on Inherited IRAs in Bankruptcy | Courthouse News Service
Wednesday, November 29, 2023
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Circuit Split on Inherited IRAs in Bankruptcy

CHICAGO (CN) - Inherited IRAs are not "retirement funds," and are not protected from creditors' claims, the 7th Circuit ruled, creating a circuit conflict.

At her death, Ruth Heffron owned an individual retirement account (IRA) worth $300,000, which passed to her daughter Heidi Heffron-Clark.

Unlike regular IRAs, inherited IRAs cannot be used as the beneficiary's retirement savings account, but must be distributed within five years. This ensures that the money held in an IRA, which is tax-free until its withdrawal, cannot be passed on through the generations without paying income tax.

This case came about when Heffron-Clark declared bankruptcy during the five-year distribution period.

Although IRA funds are generally protected from creditor's claims, the bankruptcy judge found that money in an inherited IRA is not exempt because it cannot be held for Heffron-Clark's own retirement.

A federal judge in Madison, Wisc., reversed that ruling, however, finding that retirement funds in a decedent's possession should be treated the same way as they were in the original owners' hands.

Since then, the 5th Circuit agreed with this reasoning in In re Chilton.

A three-judge panel of the 7th Circuit created a circuit split Tuesday while reviewing Heffron-Clark's case, finding that, "by the time the Clarks filed for bankruptcy, the money in the inherited IRA did not represent anyone's retirement funds." (Emphasis in original.)

"They had been Ruth's, but when she died they became no one's retirement funds," Chief Judge Frank Easterbrook wrote for the panel. "The account remains a tax-deferral vehicle until the mandatory distribution is completed, but distribution precedes the owner's retirement. To treat this account as exempt under §522(b)(3)(C) and (d)(12) would be to shelter from creditors a pot of money that can be freely used for current consumption."

The opinion asks readers to suppose Ruth had withdrawn the money from her IRA before her death, paid taxes on the money, and given the money to her daughter.

"Why should it make a difference whether the money passed to Heidi on Ruth's death or a little earlier?" Easterbrook asked. "Either way, the money used to be 'retirement funds' but isn't now."

Noting that its decision created circuit split, the court concluded: "The bankruptcy judge got this right. We disagree with the Fifth Circuit's decision in Chilton. Because our conclusion creates a conflict among the circuits, we circulated the opinion before release to all judges in active service. None of the judges requested a hearing en banc."

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