By Columbia – Lexington Bankruptcy Attorney Lex Rogerson
State law exemption means Supreme Court decision exposing inherited IRA’s should not impact SC bankruptcy filers
The U.S. Supreme Court recently held that the federal bankruptcy exemption does not protect an individual retirement account inherited by a person who later files bankruptcy. Clark v. Rameker, 573 U.S. ___ (2014). But that decision should not affect Columbia area residents much, because a South Carolina state law exemption expressly covers IRA’s in the hands of successors to the original account holder.
The Clark IRA decision.
Heidi Heffron-Clark and her husband, of Stoughton, Wisconsin, filed a chapter 7 bankruptcy in 2010. Several years before, Heidi’s mother had died, leaving her the beneficiary of an IRA account worth $450,000.
The Clarks drew part of the funds but when they filed, $300,000 remained in the account. Heidi claimed the account as exempt under a Bankruptcy Code section protecting retirement accounts that are tax-exempt under the IRA section of the Internal Revenue Code.
The trustee of their case and one creditor objected, contending that an inherited IRA is legally different from one owned by the person who originally established the account. The bankruptcy judge agreed, disallowing the exemption. The intermediate appellate courts split on the issue, and the Supreme Court agreed to hear the case.
On June 12, 2014, the high court issued a decision agreeing with the bankruptcy judge. It disallowed the exemption because it concluded an inherited IRA is no longer a “retirement account,”, i.e., an account set aside for retirement. Under the law applicable to inherited accounts,
- the owner is not allowed to make any additional contributions to the account;
- the funds can be withdrawn at any time for any purpose; and
- the owner must withdraw the funds within 5 years or take annual distributions, no matter how far she may be from retirement.
The funds from Heidi’s mother were therefore available to her creditors. Likewise, other bankruptcy debtors who use the federal exemptions set out in the Bankruptcy Code, or state exemptions that are materially identical to those, cannot exempt IRA’s which they have inherited.
Why South Carolina is different
Bankruptcy laws permit states to decide what property their citizens can protect. Every state has set up its own list of exempt property, which also applies in bankruptcy cases. States can even “opt out” of the federal bankruptcy exemptions, making them unavailable to their residents.
South Carolina has done both. As a result, bankruptcy filers who have lived in this state for over two years can only use the exemptions enacted in the state code of laws.
The IRA exemption under South Carolina law is considerably broader than the federal counterpart. The state provision refers to “individual retirement accounts as described in . . . the Internal Revenue Code.” It does not use the term “retirement account” by itself and therefore does not appear limited to accounts that are currently being held solely for retirement. In addition, the state provision specifically makes the exemption available where the debtor owns the account “as a participant, beneficiary, contingent annuitant, alternate payee, or otherwise.” So the South Carolina exemption appears to be drawn specifically to cover the inherited IRA situation that the Supreme Court addressed in Clark.
The Clark decision can still affect those who file bankruptcy after living in South Carolina for less than two years. Those debtors are left to either the federal exemption at issue in Clark or state exemptions which may be closer to the federal exemption than to South Carolina’s. On the other hand, some states, including Texas and Virginia, also have extended express protection to inherited IRA’s.
The South Carolina IRA exemption has not yet been interpreted by the courts. But the plain language of the statute appears to protect the same inherited IRA accounts that Clark says are not within the federal exemption.