By: Jacqueline Z. Fox, Esq., LL.M.
In the recent case of In Re Todd , No. 15-11083 (Bankr. N.D.N.Y. March 23, 2018), the United States Bankruptcy Court for the Northern District of New York held that a debtor’s inherited Individual Retirement Account (“IRA”) is property of the debtor’s bankruptcy estate and consequently not exempt from creditors under New York law.
Laurie Todd (the “Debtor”) was the beneficiary of one of her mother’s IRAs. After the Debtor’s mother passed away, the Debtor used the funds received to establish an inherited IRA through Charles Schwab. In this regard the facts of the case provide that the Debtor did not make any contributions to the inherited IRA from her own funds; had unfettered access to the funds in the inherited IRA; and continued to withdraw funds from the inherited IRA at the time of the case decision.
Seven years or so after the Debtor established the inherited IRA she filed a chapter 11 bankruptcy case and claimed the inherited IRA to be exempt from her bankruptcy estate pursuant to New York statute, N.Y. C.P.L.R. § 5205 (“Section 5205”). Debtor claimed the inherited IRA to be exempted because she was an individual indemnitor subject to joint and several liability to a surety under a general indemnity agreement, and she wanted to protect the inherited IRA from such a claim given that it was the largest asset in her bankruptcy estate.
Notably, Section 5205 provides several circumstances in which IRAs may be exempt from the judgment of a creditor under New York law. More specifically, Section 5205(a)(1) states in relevant part that an exemption from the satisfaction of a money judgment is provided for “all property while held in trust for a judgment debtor, where the trust has been created by, or the fund so held in trust has proceeded from, a person other than the judgment debtor . . .”; however, the Court noted that if the debtor is capable of using funds in the account without restriction, then the Section 5205(a)(1) exemption would not be available to the debtor. As noted above, the facts of the case provide that the Debtor had unfettered access to the funds in the inherited IRA and continued to access funds at the time of the case decision; as a result, the Court held that the Debtor could not avail herself of the exemption provided under Section 5205(a)(1).
Next, the Court looked at Section 5205(a)(2) which provides in relevant part an exemption for an account which is qualified as an individual retirement account under Internal Revenue Code Section 408 (“Section 408”). In its analysis, the Court noted that neither Section 5205 nor Section 408 defined the word “qualified”, and given such ambiguity the Court looked to the legislative history of Section 5205 for further clarification. In this regard the Court found that a review of the legislative history clearly provided that the purpose of Section 5205(c)(2) was “to protect individuals’ accounts established for their retirement .” Thus the Court stated that a holding that inherited IRAs are “qualified” under Section 5205(c)(2) “would be fundamentally inconsistent with the statute’s purpose” because (i) inherited IRA holders cannot contribute to the account, and thus “cannot be used to actively save money for retirement”; (ii) funds in inherited IRAs can be “accessed at any time without penalty”; and (iii) “inherited IRA holders are under an obligation to draw down their accounts”. For these reasons, the Court found that the Debtor’s inherited IRA was not exempt as a qualified retirement account under Section 5205(a)(2).
In addition, the Court noted that while many other state legislatures (such as Alaska, Arizona, Florida, Missouri, North Carolina, Ohio, and Texas) have amended their state exemption statutes to specifically exempt inherited IRAs, the New York legislature has not done so.
Because many times an IRA will be one of the largest assets owned by a client and is by nature heavily relied upon for future financial needs, proper IRA planning should be strongly considered; particularly for those that want to ensure (i) maximum tax deferred growth by proper funding of the IRA, (ii) that necessary withdrawals are made timely, and (iii) the manner in which the desired beneficiary will receive continued required distributions. That is, without proper planning, if an inherited IRA is left directly to ones heirs, said heirs may withdraw and expeditiously deplete the account which would consequently trigger unnecessary income tax consequences while eliminating the benefits and protections of long term tax deferral. In addition, and as illustrated in the In Re Todd case discussed above, IRAs inherited outright may also be subject to creditors and be exposed to divorce proceedings; as such, money withdrawn from inherited IRAs has the potential of being exposed to creditor attachment.
Given these reasons, proper IRA planning that utilizes a trust may offer several advantages including protecting an inherited IRA from creditors and spendthrift beneficiaries, while assuring realization of long term tax deferral. Moreover, if there is no pressing need for cash, leaving the IRA in a trust allows the trustee of such trust to ensure that only the minimum required distributions are taken so that the account isn’t quickly depleted in the case of a spendthrift beneficiary. Lastly, placing ones IRA in a trust may also reassure the owner of such IRA that the people he or she desires to inherit the IRA asset will in fact inherit such assets. This in turn would avoid the possibility of the IRA owner’s surviving spouse (or that of a beneficiary) passing the IRA assets to a future spouse or to children of a subsequent marriage.
Please contact our office if you are interested in creating such a trust for your IRA.
*The information in this article is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Greenspoon Marder LLP or the individual author(s), nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.
