While the bankruptcy protection afforded to contributory and rollover individual retirement accounts is clear, the protection given to inherited IRAs isn’t as well defined. As of mid-2011, nearly 40 percent of U.S. households owned at least one type of IRA,1 making the ability to protect such assets an important issue to many clients. 


Bankruptcy Basics

There are generally two types of bankruptcy filings available to individuals: Chapter 7 and Chapter 13. Both are governed by the federal Bankruptcy Code, which is codified as Title 11 of the United States Code.

Chapter 7 involves the liquidation of the assets consisting of the bankruptcy estate. To qualify for a Chapter 7 filing, the debtor must satisfy a means test as outlined in the Bankruptcy Code. Once the assets are liquidated (that is, converted to cash), they’re distributed to creditors, subject to the exemption of certain assets and the rights of secured creditors. At the close of the bankruptcy proceeding, the debtor receives a discharge from debts.

Chapter 13, “Adjustment of Debts of an Individual with Regular Income,” allows the debtor to propose a plan to repay creditors over time. This filing is designed for debtors who have a regular source of income or who don’t satisfy the above-mentioned means test. Chapter 13 can be more desirable than Chapter 7 in that it may allow the debtor to keep certain assets, such as a home or vehicle. Chapter 13 also allows a slightly broader discharge of debts, such as debts for willful and malicious injury to property and debts arising from a property settlement in a divorce. Upon the completion of the payment plan, the debts are discharged.

11 U.S.C. Section 522 contains a list of property that a debtor can exempt from his bankruptcy estate.


Pre-2005 Cases

Before the Bankruptcy Code was amended in 2005 (discussed below), retirement accounts were governed by either: (1) state exemption law if the state had opted out of the Bankruptcy Code exemptions; or (2) the limited set of Bankruptcy Code exemptions found in 11 U.S.C. Section 522.

The U.S. Supreme Court held that IRAs were exempt from a bankruptcy estate under 11 U.S.C. Section 522(d)(10)(E) (to the extent the assets were reasonably necessary for the support of the account holder and any dependents).

In Rousey v. Jacoway,2 the petitioners filed for Chapter 7 bankruptcy several years after rolling over distributions from their pension plans into IRAs. They sought to shield portions of their IRAs from their creditors by claiming the portions as exempt from the bankruptcy estate under 11 U.S.C. Section 522(d)(10)(E), which provides that a debtor may withdraw from the estate his right to receive “a payment under a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of . . . age.” Both the Bankruptcy Court and the U.S. Court of Appeals for the Eighth Circuit sustained the bankruptcy trustee’s objection to exempting the IRAs. In disallowing the exemption, the Eighth Circuit concluded that, even if the petitioners’ IRAs were “similar plans or contracts,” they gave the petitioners no right to receive payment “on account of age,” but were, instead, savings accounts readily accessible at any time for any purpose, so long as the petitioners were willing to pay a 10 percent penalty that applied to withdrawals from IRAs made before the accountholder turns 591/2. On review, however, the Supreme Court disagreed and stated that the petitioners’ right to payment from the IRAs was connected to their age because of the 10 percent penalty.

The question still remained, however, whether inherited IRAs were given the same level of protection. The case law at that time wasn’t favorable to debtors. For example, in In re Navarre, the debtor inherited a portion of an IRA from his mother.3 In his subsequent Chapter 7 filing, when state law governed exemptions, the debtor contended that the proceeds from his mother’s IRA were exempt pursuant to Alabama law. The Navarre court, however, found that an inherited IRA isn’t equivalent to an IRA because the Tax Code treats an inherited interest different from an IRA. Likewise, in In re Sims, the court held that, as a matter of Oklahoma law, an inherited IRA isn’t exempt from the bankruptcy estate.4

Finally, in In re Greenfield, the debtor inherited an IRA from her father, had taken regular required minimum distributions and subsequently filed a Chapter 7 bankruptcy petition.5 The court held that because the debtor was primarily using the IRA for purposes other than retirement, it wasn’t exempt. Beneficiaries of inherited IRAs were also denied bankruptcy exemptions in Anderson v. Seaver and in In re Stover.6


2005 Amendment 

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the Act) expanded plans that are protected in bankruptcy cases to include traditional IRAs and Roth IRAs.7 Specifically, the Act provides protection for retirement assets to the extent that they’re in a fund or account that’s exempt from taxation under IRC Sections 401,8 403,9 408,10 408A,11 414,12 45713 or 501(a).14 Two elements must be present for a retirement account to fall under the 11 U.S.C. Section 522(b)(3)(C) exemption. First, the amount the debtor seeks to exempt must be retirement funds, and second, such retirement funds must be in an account that’s exempt from taxation under Sections 401, 403, 408, 408(A), 414, 457 or 501(a).

As discussed above, only stock bonus, pension, profitsharing, annuity or similar plans or contracts were previously protected from creditors. But now, traditional IRAs and Roth IRAs are also explicitly exempt from the bankruptcy estate up to $1 million (adjusted for inflation).15 This $1 million limit for IRAs and Roth IRAs doesn’t include rollover contributions,16 nor is it applicable to simplified employee pensions under IRC Section 408(k) or simple retirement accounts under IRC Section 408(p). If a debtor rolled over $3 million from a qualified plan into an IRA, for example, the entire $3 million, plus earnings, is protected. Traditional IRA and Roth IRA owners can now feel confident that their accounts will be protected without having to look to applicable state law in hopes of obtaining favorable treatment. Because the Act stayed silent on inherited IRAs, however, the question still remained as to how they would be treated under this amendment. 


Recent Developments

The bankruptcy courts have been divided as to whether the Act protects inherited IRAs. Until recently, most courts ruled in favor of the bankruptcy trustee and denied exemptions to inherited IRAs.

When holding that an inherited IRA wasn’t exempt from the bankruptcy estate, the bankruptcy courts often found that an inherited IRA was significantly different from an IRA under the IRC. The bankruptcy courts have listed the following differences between an IRA and an inherited IRA:


1. A beneficiary of an inherited IRA can’t make contributions to the account;

2. A beneficiary of an inherited IRA can’t roll the IRA into another retirement plan; and

3. Distributions from an inherited IRA must begin within a year or be entirely distributed within five years.


In most of the unfavorable cases, the bankruptcy courts distinguished inherited IRAs from IRAs and allowed a creditor to reach the inherited IRA. In In re Klipsch, for example, the court stated that “inherited IRAs are not meant to be treated as retirement plans under either the Internal Revenue Code or the Indiana Code.”17 The court based this conclusion on the fact that inherited IRAs can’t be rolled over, that beneficiaries of inherited IRAs may make withdrawals at any time without penalty and that distributions must commence within one year or the entire amount must be distributed within five years.

In In re Kirchen, an inherited IRA wasn’t allowed a bankruptcy exemption because it “had transformed into a source of immediately payable income to the Debtor, regardless of his age or retirement status” and, therefore, wasn’t received “by reason of age, illness, disability, death or length of service,” as required under Wisconsin law.18

In In re Jarboe, the court stated that “it is not enough for an account merely to be called an IRA; the account must also satisfy the hallmarks of an IRA.”19 The court pointed to the above-mentioned differences in the treatment of inherited IRAs in holding that an IRA inherited from someone other than a spouse may not be claimed as exempt from the bankruptcy estate.

More recently, however, there’s been a strong shift in favor of debtors.

In In re Thiem, the court disagreed with those courts that denied the exemption, stating that even though inherited IRAs are treated differently under the IRC, they’re still protected from taxation until amounts are required to be distributed.20 The court pointed out that the IRC and underlying regulations ensure that the original retirement funds are protected and remain unchanged in character, for example by prohibiting contributions and rollovers to the account. It further stated that both ordinary and inherited IRAs are exempt from taxation, and that’s all that 11 U.S.C. Section 522 requires.

The Thiem court also indicated that none of the cases denying exemption analyzed 11 U.S.C. Sections 522(b)(3)(C) or 522(b)(4)(C). The plain language of Section 522(b)(4)(C) provides that transfers of the type that create an inherited IRA don’t cause a loss of exemption eligibility. In addition, the court didn’t agree with the cases that required a retirement purpose to obtain exemption by stating that neither Section 522(b)(3)(C) nor Section 522(d)(12) require the retirement funds to be those originally created by the debtor-beneficiary. Instead, the court held that an inherited IRA that complies with the IRC is, in name and substance, an account that meets the requirements of the federal retirement exemption statutes at issue.

In In re Clark, the bankruptcy court originally found that the trustee had the more persuasive argument by looking at the ordinary meaning of a retirement fund as found in Webster’s dictionary, which defines the term “retirement” as “withdrawal from one’s position or occupation or from active working life.”21 The court concluded that because the funds weren’t held in anticipation of “withdrawal from one’s position or occupation,” the inherited IRA didn’t contain any living person’s “retirement funds.” Even though courts in other jurisdictions had found that an inherited IRA did constitute retirement funds, the bankruptcy judge felt that the fact that the funds were once held for the decedent’s retirement was irrelevant. It’s the purpose of the fund, the court stated, and not its name, that determines the plain meaning of the phrase.

On appeal, both the debtors and the district court pointed out that, with the exception of this case and one other, all of the bankruptcy courts and district courts that have addressed this issue have ruled in favor of the debtors. The district court cited In re Nessa, which held that the term “retirement funds” applied to any account that contained funds set aside for retirement, so long as the funds had been accumulated for retirement purposes originally and that the Bankruptcy Code doesn’t specify that the funds must be the debtor’s retirement funds.22

The issue for the Clark court came down to one question: Do retirement funds held in a traditional IRA account lose their character upon the death of the account owner before the funds pass to a non-spouse beneficiary? The minority agreed with the bankruptcy court that the funds don’t remain retirement funds after transfer because the term “retirement funds” in the Bankruptcy Code refers only to funds set aside by the debtor to be used for her or her spouse’s own retirement and not to retirement funds accumulated by someone else, but inherited by the debtor. The majority, however, concluded that Congress never put any such qualification on the term. Instead, the majority agreed with the Nessa court in not distinguishing between an account built up by a decedent and inherited by a debtor and an account made up of contributions by the debtor herself.

The only remaining question was whether the funds remained tax exempt after the transfer to the inherited IRA. The bankruptcy court also felt that the inherited IRA didn’t meet the tax-exempt requirement. The judge indicated that, “No one has cited (and I can find none) any primary legal source for the proposition that the debtors’ inherited IRA is tax exempt.”

While the court thought that the difference in treatment between traditional IRAs and inherited IRAs meant that the latter don’t qualify as tax-exempt funds, the district court found that while there are different rules about the amounts and timing of distributions and whether they can be rolled over, the principal and interest earnings are exempt from income taxes until they’re distributed. The district court found this sufficient to make both types of account tax exempt, especially given the plain language in IRC Section 408(e)(1), which states that “[a]ny individual retirement account is exempt from taxation under this subtitle” (emphasis added).

Again, in In re Seeling, the court disagreed with the trustee’s argument that the funds held in the inherited IRA weren’t “retirement funds” because the debtor didn’t herself contribute the funds for purposes of her own retirement.23 Instead, the court agreed with the debtor’s argument that there’s no requirement that the funds had been originally set aside by the debtor in contemplation of retirement. In concluding that IRAs are tax exempt under IRC Section 408 and, accordingly, are exempt under the Bankruptcy Code, the court found that the Bankruptcy Code only requires that the funds have been placed in a particular form of a retirement investment vehicle. (For a summary of cases by districts, see “Granted or Denied?” p. 35.)


IRA Payable to Trust

More and more cases are coming down on the side of the debtor, making it clearer how inherited IRAs will likely be treated in a bankruptcy action. However, protection continues to be uncertain and, especially in those jurisdictions that have unfavorable or conflicting precedent, it’s still generally advisable to have an IRA payable to a trust24 for the benefit of the individual beneficiary to obtain stronger asset protection. In addition, having an IRA payable to a trust, rather than an individual, protects against the designated beneficiary moving to a jurisdiction with unfavorable precedent.               



1. Investment Company Institute, 2012 Investment Company Fact Book, 52nd Edition.

2. Rousey v. Jacoway, 544 U.S. 320 (2005).  

3. In re Navarre, 332 B.R. 24 (Bankr. M.D. Ala. 2004).

4. In re Sims, 241 B.R. 467 (Bankr. N.D. Okla. 1999).

5. In re Greenfield, 289 B.R. 147 (Bankr. S.D. Ca1. 2003).

6. Anderson v. Seaver, 269 B.R. 27 (B.A.P. 8th Cir. 2001); In re Stover, 332 B.R. 400 (Bankr. W.D. Mo. 2005).).

7. Public Law 109-8.

8. Qualified pension, profitsharing and stock bonus plans.

9. Employee annuities.

10. Individual retirement accounts.

11. Roth IRAs.

12. Multi-employer annuities.

13. Deferred compensation plans of state and local governments and tax-exempt organizations.

14. Tax-exempt organizations.

15. The $1 million limit can also be increased if the “interests of justice so require.”

16. Under Internal Revenue Code Sections 402(c), 402(e)(6), 403(a)(4), 403(a)(5) and 403(b)(8).

17. In re Klipsch, 435 B.R. 586 (Bankr. S.D. Ind. 2010).

18. In re Kirchen, 344 B.R. 908 (Bankr. E.D. Wisc. 2006).

19. In re Jarboe, 365 B.R. 717 (Bankr. S.D. Tex. 2007).

20. In re Thiem, 107 A.F.T.R.2d 2011-529 (Bktcy Ct. Ariz.).

21. In re Clark, 109 A.F.T.R.2d 2012-733 (466 B.R. 135).

22. In re Nessa, 426 B.R. 312 (B.A.P. 8th Cir. 2010).

23. In re Seeling, 109 A.F.T.R.2d 2012-2407 (471 B.R. 320).

24. Specifically, one that complies with the designated beneficiary requirements of Treasury Regulations Section 1.401(a)(9)-4, Q&A 5.