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CCH® PENSION — 07/12/12

Funds in inherited IRA were exempt from debtor’s bankruptcy estate

Proceeds from a deceased person’s annuity account that were transferred to a debtor’s inherited individual retirement account (IRA) prior to bankruptcy were exempted from the debtor’s bankruptcy estate under Bankruptcy Code Sec. 522(d)(12), according to a U.S. Bankruptcy Court. The rolled over amount was exempt from taxation under Code Sec. 408(e), and the funds did not cease to qualify for exemption because of a direct transfer from one tax-exempt account to another tax-exempt account.

Debtor seeks bankruptcy estate exemption for inherited IRA funds

Prior to filing for bankruptcy, a debtor inherited funds in a deceased person’s tax-exempt annuity account. Per the debtor’s request, her share of the funds in the annuity account was transferred over to an inherited IRA set up for her benefit. Approximately four years later, the debtor filed a voluntary Chapter 7 bankruptcy petition, claiming an exemption from her bankruptcy estate for the full value of her IRA pursuant to Bankruptcy Code Sec. 522(d)(12). The Chapter 7 trustee objected to the debtor’s claim of exemption of the IRA.

According to the court, the issue to be decided, whether Bankruptcy Code Sec. 522(d)(12) may be used to exempt an IRA whose proceeds have been inherited, appeared to be a question of first impression in the First Circuit. The court explained that Bankruptcy Code Sec. 522(d)(12) allows a debtor to exempt from his or her bankruptcy estate "[r]etirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986."

The trustee contended that the inherited IRA did not meet the two requirements necessary to be exempt under Bankruptcy Code Sec. 522(d)(12). First, the funds in the inherited IRA were not "retirement funds" because the debtor did not contribute the funds for her own retirement. Second, the trustee argued that the inherited IRA was not exempt from taxation under Code Sec. 408(e), but instead was exempt from taxation under Code Sec. 402(c)(11). Code Sec. 402(c)(11) is not included in the list of applicable IRS code sections in Bankruptcy Code Sec. 522(d)(12).

Inherited IRAs are retirement funds

After explaining that the term "retirement funds" is not defined in Bankruptcy Code Sec. 522(d)(12) or anywhere else in the Bankruptcy Code, the court concluded that the statutory language means "a description of money set apart for retirement." However, the court observed that the statutory language does not specify for whose retirement the money must be apart to qualify for exemption.

The court cited the Fifth Circuit case, In re Chilton in which the appellate court noted that "[m]ost of the courts that have analyzed this issue have concluded that inherited IRAs are ‘retirement funds’ as that phrase is used in §522(d)(12)." In the present case, the court concluded that it was in agreement with the other courts. IRAs are tax exempt under Code Sec. 408 and, thus, exempt under the Bankruptcy Code. The Bankruptcy Code does not require an investigation into where the funds come from. All the Bankruptcy Code does require is that the funds are in a particular form of retirement vehicle in order to be tax exempt. According to the court, the inherited IRA in the present case was included in the list of exempt vehicles in Bankruptcy Code Sec. 522(d)(12) and there was no statutory basis for adding additional conditions for bankruptcy exemption. As to the trustee’s argument that the inherited IRA was governed by Code Sec. 402(c)(11) and not by Code Sec. 408(e), the court disagreed. The court found that the transfer itself was exempt from taxation under Code Sec. 402(c)(11), but once the funds were transferred, the funds were exempt under Code Sec. 408(e).

Source: In re Holly Anne Seeling, Debtor (Bankr Ct MA).

For more information, visit http://www.wolterskluwerlb.com/rbcs.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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