Seventh Circuit Reverses Trend of Exemption for
Inherited IRAs
Submitted by Abigail C. Waeyaert
As published in the Califf & Harper, P.C. August 2013 Newsletter
The Seventh Circuit has reversed the trend of courts across the country finding inherited IRAs are exempt in bankruptcy.  

An inherited IRA is an IRA that is inherited by a non-spouse beneficiary (i.e. you inherit your mother's IRA upon her death). Certain property is exempt in bankruptcy, including IRAs in some states, meaning creditors' claims cannot be paid from that property. Courts across the country that have addressed the issue of whether or not inherited IRAs are exempt in bankruptcy have come to differing conclusions, some finding inherited IRAs are exempt while others have found inherited IRAs are not exempt.  

As noted in our previous article "Protection of Inherited IRAs in Bankruptcy," seen in the Califf & Harper, P.C. December 2011 Newsletter and updated in the Califf & Harper, P.C. August 2012 Newsletter, the trend has been for courts to allow the exemption for inherited IRAs. A recent decision in the Seventh Circuit has reversed this trend. 

In April 2013, the Seventh Circuit, the federal circuit with jurisdiction over Illinois, Indiana, and Wisconsin, found that an inherited IRA is not exempt from creditor claims in bankruptcy. To be exempt under federal law, the inherited IRA must meet two requirements:

1. The inherited IRA must be considered "retirement funds", and  
2. The inherited IRA must be exempt from taxation.  
One of the main issues dividing courts on whether inherited IRAs are exempt is the question of whether the assets are considered "retirement funds." 

The Seventh Circuit determined that an inherited IRA is not considered "retirement funds" and therefore does not meet the test for exemption in bankruptcy. In support of its decision, the Court emphasized that an inherited IRA, in contrast to a traditional IRA, must begin distributing its assets within a year of the original owner's death and must be paid out completely in as little as five (5) years. The Court was of the opinion that nothing tied the funds in an inherited IRA to the account owner's retirement stating, "An inherited IRA does not have the economic attributes of a retirement vehicle, because the money cannot be held in the account until the current owner's retirement."  

This decision creates a split among the federal circuits confronting this issue. At least one case issued since this decision, a bankruptcy court in South Carolina, has rejected the Seventh Circuit's reasoning continued the trend in favor of exemption.
For more information on this topic please contact Califf & Harper, P.C. by calling 309-764-8300 or 1-888-764-4999. This article is intended to provide general information regarding the topic discussed herein but is not intended to constitute individual legal advice.