Inherited IRAs: Exempt Asset, or Not?

As many readers of our blog probably know, IRAs (Individual Retirement Accounts) are exempt under New York State Debtor and Creditor Law and the federal Bankruptcy Code. An exempt asset means that an individual can file for Chapter 7 bankruptcy and keep that asset after the bankruptcy filing. The reason for this exemption is twofold: (1) IRAs are deemed "spendthrift trusts" under New York State and federal law; and (2) the purpose of the law is to give debtors a "fresh start" with some assets, and especially to protect retirement monies for debtors.

As with many topics in bankruptcy, sometimes there is not necessarily a clear answer to an issue. While the law is clear with respect to IRAs (New York State law provides that IRAs of any value are exempt assets, with limited exceptions, and the Bankruptcy Code allows exemption of up to $1,245,475 in IRAs or Roth IRAs), what about inherited IRAs? An inherited IRA is an IRA that debtor inherits from a family member, generally a parent, and the distinction from a regular IRA is that the debtor's earnings were not used to fund the IRA, but instead the monies were rolled over from the IRA of a deceased family member, usually after the death of the family member.

Several Bankruptcy Trustees around the country have raised the issue of whether inherited IRAs should be deemed exempt in bankruptcy. In the Southern District of New York, in In re Cutignola, 450 B.R. 445 (Bankr. S.D.N.Y. 2011), the exempt IRA of a debtor who died post–petition passed to her co–debtor husband through her will. The Bankruptcy Trustee moved for turnover of the IRA to the bankruptcy estate, arguing that the IRA lost its exempt status when it was transferred to the husband. In its analysis, the Court looked at the language of Bankruptcy Code § 522 and concluded that if the funds are: (1) retirement funds; (2) in an account exempt from taxation; (3) and arrived in that account through a direct transfer, the funds remain exempt. Accordingly, the Bankruptcy Trustee's turnover motion was denied.

While the issue has not been definitively settled, this author's opinion is that in the Southern and Eastern Districts of New York, inherited IRAs are exempt.

The question of what assets are exempt in bankruptcy is very complex, depending on the asset, the jurisdiction and the type of bankruptcy relief sought. For more information, please contact Jim Shenwick.