In Clark v. Rameker, a case decided by the U.S. Supreme Court on June 12, 2014, the Court ruled that an inherited IRA did not constitute “retirement funds” under the Federal Bankruptcy Code and, therefore, those funds were not exempt assets of the bankrupt estate and were subject to the claims of creditors. However, if the case had involved Maryland residents the outcome would have been different. Why? Because Maryland is one state that has chosen not to follow the Federal Bankruptcy Code’s exemptions. A Maryland resident must use Maryland’s exemption statute, found at Courts & Judicial Proceedings Article §11-504. This statute is worded much differently than the Federal law as it applies to IRAs. The Bankruptcy Code includes language exempting “retirement funds”, it is this language with which the Court decided the case.
In the Supreme Court case Mrs. Clark inherited a “traditional” (non-Roth) IRA from her mother. The Clarks (wife and husband) elected to take monthly distributions of same. They subsequently filed for bankruptcy protection.
The Supreme Court concluded that the Inherited IRA funds were not “retirement funds”, which are exempt from a bankrupt’s estate under the Federal Bankruptcy Code, because they were not set aside by the Clarks for their own retirement. The Court stated that public policy weighed against protecting funds in bankruptcy which were not actually set aside by the IRA holder for his or her retirement, to the detriment of creditors. In so ruling, it rejected the Clarks argument that the funds as distributed retained their character as “retirement funds” for the Clarks because they were the retirement funds of the decedent.
By contrast, Maryland’s exemption for pensions and IRAs does not use the terms “retirement funds” and is more precise in its wording: “…any money or other assets payable to a participant or beneficiary from, or any interest of any participant or beneficiary in, a retirement plan qualified under…[Internal Revenue Code sections omitted, emphasis added]…shall be exempt from any and all claims of the creditors of the beneficiary or participant, other than claims by the Department of Health and Mental Hygiene.” It seems the Maryland law would have exempted the Clarks’ inherited IRA as the monies in the account were “any money or other asset”.
The naming of trusts as beneficiaries or an election by Mrs. Clark to treat her mother’s IRA as her own may have provided the exemption from bankruptcy under Federal law the Clarks sought, but in Maryland the bankruptcy exemption of the inherited IRA seems to be clear. Although it should be noted that the Court of Appeals in Maryland has not yet interpreted the language in a dispute so there will likely need to be litigation on the matter before one can say with any certainty whether “any money or other assets” truly means just that.
The bankruptcy treatment of pension plans and IRAs can be difficult and confusing. As can the tax treatment and estate planning for them.