Section 11 U.S.C. 522(d)(12) of the Bankruptcy Code allows a debtor to protect retirement funds in an account that is exempt from taxation under the Internal Revenue Code of 1986. Retirement accounts set up under Sections 401, 403, 408, 408A, 414, 457 and 501(a) of the Internal Revenue Code of 1986 are known as traditional retirement accounts, and are fully protected in both Chapter 7 and 13 Bankruptcy. The purpose of traditional retirement accounts is to allow holders to put away money to be used at some future date when the debtor stops working.

Retirement accounts that are inherited by a debtor from somebody else, or that a debtor receives as part of a divorce settlement, are a different matter. Two opinions, one from the U.S. Supreme Court and a second from the Eastern District Of Michigan, both concluded that if such retirement accounts “become pots of money for current consumption”, they cannot be protected in bankruptcy.

The U.S. Supreme Court, in the case of Clark v. Rademaker, 573 U.S. 122, 134 S. Ct. 2242 (2014) examined how the characteristics of a traditional or Roth IRA change upon inheritance. The Clark Court articulated the following changes under the Internal Revenue Service Code that occur to an IRA upon inheritance, as follows:

1. Once he inherits, the holder of the inherited IRA cannot contribute additional funds into the account.
2. Once he inherits, the holder of the inherited IRA must either empty out the IRA within five years after the year of the owner’s death or take minimum distributions every year.
3. Once he inherits, the holder of the inherited IRA can cash out the entire balance at any time for whatever reason without incurring a penalty.

Because of these changes, the Clark Court concluded that inherited IRA’s become funds that can be used for current consumption, as such are NO LONGER retirement funds and therefore cannot be protected in bankruptcy.

In Kelly James Kizer, 13-58567-TJT (2015), the debtor was awarded a part of his spouse’s 401K in a Judgement of Divorce. The Kizer Court applied the analysis articulated by the Supreme Court in Clark. The Kizer Court was presented with no evidence that the debtor had to withdraw the funds or that he had to take minimum distributions. However, the Court did find that the debtor was unable to contribute into the 401K, and the Court also found that the debtor had withdrawn funds out of the 401K without incurring penalties. This was enough for the Court to conclude that the 401K account was no longer a traditional retirement account and therefore could not be protected in bankruptcy.

The debtor in Clark acquired her IRA through inheritance. The debtor in Kizer acquired his 401K through a divorce action. The conclusion is that whether the debtor acquired the retirement account through inheritance or divorce, it cannot be protected unless he is able to contribute to it and he cannot cash it out without incurring a penalty.

Please contact the law offices of Joseph L. Grima and Associates P.C. at (313) 385-4076 so that we may discuss whether a bankruptcy filing will impact your retirement plan.