Update on Inherited IRAs

Posted By Jay Kaufman || 15-May-2011

For Clients, Professional Advisors

Since my March 3, 2011 posting on inherited IRAs, there has been an interesting precedent. A Federal Court in Texas has issued an important appellate decision. The case is Chilton v. Moser.

What happened? Shirley died in 2007 naming Janice as beneficiary of her $170,000 IRA. Janice opened an IRA titled, “Janice, beneficiary of Shirley IRA” and transferred the funds to this account. Janice filed a bankruptcy petition in December, 2008. Janice sought to protect the IRA from the bankruptcy estate, claiming that the assets were exempt from her creditors under Federal law. The United States Trustee objected. The bankruptcy court judge held that the assets were part of the bankruptcy estate and that they could be distributed to the creditors. Janice appealed to the Federal District Court.

In a well-reasoned appellate decision, Judge Ron Clark reversed the bankruptcy court decision. He held that in order for inherited IRA funds to be exempt from creditors in a bankruptcy (a) they must be tax exempt under §401 or §408 or §403 (or other) section of the Internal Revenue Code (covering individual retirement accounts, pension and profit sharing plans and certain non-profit organization annuity plans) and (b) they must be retirement funds.

The court went on to conclude that Shirley’s funds were both tax-exempt and were retirement funds. Therefore, the exemptions under the bankruptcy code applied and the money was in fact Janice’s. Her creditors in the bankruptcy case would be unable to reach them!

Can Illinois residents rely on these cases? The trend of the decisions is clear. All Federal District Court Decisions to date and one Appellate Court decision has been consistent with the holding in Chilton v. Moser.

However, one cannot say for certain that this is the law of the land. There is some likelihood that the Federal appellate courts will differ in how they apply the bankruptcy code to IRAs. Nationally respected IRA and tax expert Bob Keebler recommends that professionals continue to offer clients an individualized IRA trust for asset protection. It provides certain asset protection.

Until the matter is resolved by the Seventh Circuit Court of Appeals (Illinois, Wisconsin and Indiana), or if the circuits disagree, by the United States Supreme Court, we continue to offer our clients with large IRA accounts an individual retirement plan trust that provides the asset protection they need.

Why take a chance if a deal goes bad?

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