Florida Inherited IRA Still Protected in Bankruptcy, Even in Light of U.S. Supreme Court Case Clark v. Rameker

On June 12, 2014, the Supreme Court of the United States issued its opinion in the matter of Clark.v.Rameker, 134 S. Ct. 2242 (2014).   In a landmark decision, the Supreme Court held that Inherited IRAs are not “retirement funds” within the meaning of the Bankruptcy Code, and as a result, such accounts are assets in the hands of the trustee in bankruptcy.  Nevertheless, for the majority of states that use “State” exemptions in bankruptcy as opposed to the Federal exemptions, state law, not federal law, may control whether inherited IRA’s are protected.  Florida residents can likely still protect inherited IRA’s in bankruptcy.

The question before the Supreme Court in Clark was whether the proceeds in an inherited IRA meet the Bankruptcy Code’s definition of retirement funds such that the proceeds are exempt from the bankruptcy estate.  The Court answered in the negative.  The Court reasoned that the plain meaning of the term retirement funds is “money set aside for the day an individual stops working.”  The Court then notes that there are three characteristics of Inherited IRAs that preclude a finding that such monies are retirement funds:

1. The holder of an inherited IRA may never invest additional money in the account, and in this way such an account is fundamentally different from Traditional and Roth IRAs.
2. Holders of inherited IRAs are required to withdraw money from such accounts irrespective of how many years the holder may be from retirement. 
3. As opposed to Traditional and Roth IRAs (which the Court defines as ‘quintessential retirement funds’), the holder of an inherited IRA may withdraw the entire balance of the account at any time—and for any purpose—without penalty

On these bases, the Court held that Inherited IRAs are not exempt from the bankruptcy estate; noting that any other outcome would frustrate the purposes of bankruptcy and provide debtors a free pass, as opposed to a fresh start. 

Analyzing the Supreme Court’s opinion mechanically illustrates its practical implications.  Where a married individual owns either a Roth IRA or Traditional IRA and leaves this IRA to a spouse at death, the beneficiary spouse has the ability to either (i) roll-over this IRA into his or her own pre-existing Roth or Traditional IRA or (ii) the beneficiary spouse may establish what is known as an Inherited IRA.  On the other hand, where a deceased individual is either not married or leaves the IRA to someone other than a spouse, the beneficiary cannot make such an election, and is compelled to take an Inherited IRA.  Prior to the Clark decision, all of the above IRAs were not includible in the bankruptcy estate.  In the wake of this opinion, only a spouse’s roll-over IRA is exempt.

The consequences of the Clark decision are uniquely significant for Florida residents.  Like many states, Florida has its own laws regarding property that is exempt from the claims of creditors.  Fla. Stat. § 222.21 is one such statute and deals primarily with the special status conferred on pension funds, including IRAs. 

The current version of this statute reads as follows:

[A]ny money or other assets payable to an owner, a participant, or a beneficiary from, or any interest of any owner, participant, or beneficiary in, a fund or account is exempt from all claims of creditors of the owner, beneficiary, or participant if the fund or account is:

1. Maintained in accordance with a master plan, volume submitter plan, prototype plan, or any other plan or governing instrument that has been preapproved by the Internal Revenue Service as exempt from taxation under s. 401(a), s. 403(a), s. 403(b), s. 408, s. 408A, s. 409, s. 414, s. 457(b), or s. 501(a).  Fla. Stat § 222.21(2)(a).

While this Statute expressly exempts from claims the same inherited IRA account at issue in Clark, this was not so in Florida as recently as three years ago.  In Robertson v. Deeb, 16 So.3d 936 (Fla. 2nd DCA 2009), the Third District held that “inherited IRAs are not entitled to the exemption set forth in section 222.21(2)(a), Florida Statutes (2008).”  Despite predating the Clark case by more than five years, Deeb mirrors its holding in declining to find that an inherited IRA is entitled to exempt status or creditor protection.  Controversy that ensued in the aftermath of the Deeb decision prompted the Florida Legislature to amend the statute—Section 222.21—upon which Deeb was decided in 2011. 

In amending the statute, the Florida House of Representatives explicitly stated that the Legislature clearly intended that inherited individual retirement accounts be exempt from claims of creditors of the owner, beneficiary, or participant of the inherited individual retirement account.  The House further called out the Deeb opinion as being contrary to the Legislature’s intent.  By adding language to the existing statute such that it contemplated and covered a beneficiary’s interest in an IRA (as opposed to original ownership only), the statute brought inherited IRAs within the sphere of assets exempt from creditor claims.  A full reading of the bill can be found here. 

The effect of the Clark decision is that Inherited IRAs are treated differently in the context of state creditor claims compared with federal bankruptcy, with such accounts no longer protected in the latter circumstance.  Whereas Florida and federal law alike previously reassured holders of Inherited IRAs that their assets would be categorically protected, that is simply no longer the case.  In light of the Supreme Court’s holding in Clark, one’s interest in an Inherited IRA is now a critical component in assessing the merits of filing for bankruptcy.

Florida is an “opt-out state”, meaning it does not use the Federal exemptions but instead requires its residents to use the Florida state exemptions.  Florida’s retirement exemption is found under Florida Statutes 222.21(2), which, as explained, was amended to protect all IRA’s, inherited or not.  Therefore, it would appear that this Supreme Court case has no bearing on the ability of Florida residents to protect inherited IRA’s.  Of course, until this idea is tested in court, one should be cautious in assuming that an inherited IRA will in fact be protected.  Also, the use of exemptions in bankruptcy is tricky, and can rely on the length of residency and the location of the actual IRA account.  Therefore, one should always consult with experienced bankruptcy counsel before filing.