Fifth Circuit: Inherited IRAs Protected in Bankruptcy

By Janet Elliott, Staff Writer
janet.elliott@texaslawbook.net

AUSTIN (March 13, 2012) – Inherited Individual Retirement Accounts qualify as retirement funds that are protected from creditors in bankruptcy, the U.S. Court of Appeals for the Fifth Circuit in New Orleans ruled this week in a case of first impression.

Although the issue has been addressed by various bankruptcy courts across the country, the Fifth Circuit’s decision was the first time it has been tackled by one of the nation’s federal appellate circuits, Judge Carl Stewart said in the opinion released Monday evening.

Robert and Janice Chilton inherited an IRA worth $170,000 from Ms. Chilton’s mother in 2007. The Chiltons established an IRA as an inherited IRA under the Internal Revenue Code.

When the Lewisville couple filed to liquidate their debts in 2008 under Chapter 7 bankruptcy, they sought to exempt the IRA from the bankruptcy estate.

In response to the trustee’s objections, the Chiltons converted their filing to a bankruptcy under Chapter 13, which requires them to repay some of their debts. The trustee again objected and U.S. Chief Bankruptcy Judge Brenda Rhoades of Plano sustained the trustee’s objection in 2010.

U.S. District Judge Ron Clark of Sherman reversed, however, citing a number of cases decided after the bankruptcy court made its ruling.

The 5th Circuit panel – which also included Judges Fortunato “Pete” Benavides and James E. Graves Jr. – said that inherited IRAs are “retirement funds” as defined in the Internal Revenue Code.

“The plain meaning of the statutory language refers to money that was ‘set apart’ for retirement. Thus, the defining characteristic of ‘retirement funds’ is the purpose they are ‘set apart’ for, not what happens after they are ‘set apart’,” the court said.

“It’s correct and it is in line with virtually every other court that has ruled on the issue,” said Robert Nicoud, who represented the Chiltons.

Nicoud, a partner in Dallas’ Olson Nicoud & Gueck, said there has been a significant increase in litigation involving the question of inherited IRAs and bankruptcy during the past three years.

The bankruptcy trustee, Christopher Moser of Dallas, was represented by his law firm colleague Tim York, of Quilling, Selander, Lownds, Winslett & Moser. York said he is considering appealing the ruling.

York had argued that once inherited, the funds from an IRA do not operate as the beneficiary’s retirement plan since the beneficiary may make withdrawals without penalty, regardless of age.

“If there is no early withdrawal penalty, it’s not for retirement, it’s for any time,” he said.

Early withdrawal fees apply when an IRA transfers to a spouse after the owner’s death. The surviving spouse must roll the money over into his or her retirement account, or create a new IRA.

York said as more people look for ways to avoid traditional wills by designating their children as beneficiaries of their IRAs, cases like the Chiltons will become more common.

“They will be able to withdraw all the money and not pay anything to their creditors,” he said.

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