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Court finds inherited IRAs aren't exempt retirement accounts under Bankruptcy Code
Clients seeking asset protection frequently use qualified retirement plans (like IRAs) to shield assets from creditors. In a case of first impression, a Bankruptcy Court has concluded that, unlike a debtor's own IRA, a debtor's inherited IRA isn't an exempt asset of her bankruptcy estate under the Bankruptcy Code.
Background on Bankruptcy Code exemption for IRAs . The Bankruptcy Code provides for two basic exemption regimes: (1) the statutory federal exemptions; and (2) exemptions under state or local law (or federal nonbankruptcy law). A state can choose to "opt out" of the federal exemption scheme by prohibiting their citizens from selecting the exemptions set out in the Bankruptcy Code. In the case at issue, the relevant state (Texas) allowed a debtor in bankruptcy proceedings to choose between the federal and state exemptions.
A federal bankruptcy exemption applies for certain tax-qualified retirement funds and accounts, like IRAs.
Background on inherited IRAs. If an IRA owner designates his spouse as beneficiary of his IRA and dies before the account is exhausted, the surviving spouse may roll over the decedent's IRA into the spouse's own IRA, or elect to treat the decedent's IRA as the spouse's own IRA.
A designated nonspouse beneficiary can't treat an inherited IRA as his own, but can make trustee-to-trustee transfers of the inherited amount to another IRA if the ownership of the new IRA is set up in the same way as the ownership of the old IRA, that is, in the name of the decedent for the benefit of the IRA beneficiary.
Facts. On Jan. 21, 2008, Janice Chilton established an IRA to receive the funds from her mother's IRA. Her mother, who had established an IRA account, naming Janice as beneficiary, died on Nov. 28, 2007. The account was titled "Janice Chilton, Beneficiary, Shirley Heil, Decedent." The assets of her mother's IRA were transferred directly to Janice's account. None of the funds or assets in the account were the result of contributions made by the debtor. Janice Chilton, who will be 52 years old in 2010, must begin taking life-span-measured distributions from the inherited IRA in 2010, or she may chose to take the entire distribution by 2013 or earlier.
Janice filed for relief under Chapter 7 of the Bankruptcy Code on Dec. 18, 2008 (although the proceeding was later converted to a Chapter 13 case), and listed the inherited IRA on her bankruptcy schedule. She elected the federal exemption scheme, and claimed that the inherited IRA was property exempt from creditors under 11 U.S.C. §522(d)(12). The bankruptcy trustee objected to the exemption claim.
Bankruptcy Court's conclusion. The Bankruptcy Court concluded that the IRA inherited by Janice Chilton from her mother was a non-exempt asset of the bankruptcy estate.
The Bankruptcy Court recognized that an inherited IRA is fundamentally different from a traditional IRA. Although there was no dispute that her mother's IRA was exempt from tax, her death and the distribution of the funds from her IRA to her daughter Janice, transformed the nature of the IRA. Janice placed the distributed funds into a new account created in her deceased mother's name from which she, as the beneficiary of the new account, had to take distributions before retirement.
This case means that asset protection planning must take into account that inherited IRAs will not be protected from creditors. | 
