Appellate Decision Supports Creditor Protection For IRA’s

A qualified employee benefit plan (e.g. Pension, Profit Sharing, 401(K) and 403(b) plans), protects the value of an employee’s account because it is exempt from the claims of creditors, including a trustee in bankruptcy. This benefit has also been extended to Individual Retirement Accounts (IRAs), although in bankruptcy, the exemption is limited to $1,000,000. Creditor protection applies to IRAs which hold funds that were “rolled over” from a qualified Pension, Profit Sharing, 401(K) or 403(b) plan. Finally, an IRA in which a spouse is named as a beneficiary is creditor protected since the spouse has the right to roll over the funds into his or her own IRA.

The issue that is still unclear is whether this exemption extends to an Individual Retirement Account that is “inherited” from another person who is not a spouse. In other words, if Mary Jones is named as a beneficiary on her mother’s IRA having a balance of $250,000 and her mother dies, is that amount subject to the claims of Mary’s creditors?

A recent decision by a district court in Texas (Chilton v. Moser, 2011 WL 938310, DCTX 3/16/11) reversed a bankruptcy court decision and held that an “inherited IRA” was, in fact, exempt from the claims of creditors and could not be brought back into a bankruptcy estate. The Court concluded that since an inherited IRA is exempt from taxation under the Internal Revenue Code, it was a form of account that Congress intended to be free from creditors.

Although the decision in Chilton was limited in scope to the jurisdiction in which it was decided (Texas), it was a well-reasoned decision and could be followed by other courts around the country. Any individual who is inheriting an IRA and desires to obtain creditor protection should consult with an attorney who is familiar with the current state of the law on this subject.