Creditor Protection for Inherited IRAs
Asset protection sometimes involves aggressive strategies and exotic offshore locations (or more mundane domestic locations, like Delaware). Don’t forget, however, that some of the very best asset protection involves a very ordinary account: the IRA.
In re Nessa, 105 A.F.T.R.2d 2010-609 (Jan. 11, 2010), held that inherited section 408 IRAs transferred to another trustee remain retirement funds prior to distribution, and can be claimed exempt under Sec. 522 (d)(12) of the Bankruptcy Code by debtor beneficiaries who are their equitable owners.
Section 522(d)(12) of the Bankruptcy Code provides a bankruptcy exemption (i.e., creditor protection) for “retirement 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).
In Nessa, the debtor filed for bankruptcy protection in January 2009. At the time of filing, she was the beneficiary of an IRA owned by her deceased father, who had died approximately four months earlier. There had been a trustee-to-trustee transfer of the funds.
The bankruptcy trustee objected to the exemption, arguing that inherited IRAs do not qualify for exemption under the statute. The US Bankruptcy Court for the District of Minnesota, however, ruled in favor of the debtor, based on its plain-language reading of section 522(d)(12).
The Nessa court reasoned that the “transferred amounts did not lose their character as retirement funds. Proper transfer of funds to another trustee upon the death of the original owner of the IRA results in continued exemption from taxation under section 408.”
The Nessa court believed that both elements of section 522(d)(12) were satisfied: the inherited IRA funds were “retirement funds”, and were held in an account exempt from taxation under section 408.
Accordingly, the trustee’s objection to the debtor’s claim of exemption was overruled, and the funds were exempt from the debtor’s bankruptcy estate.
Greg Herman-Giddens discussed Nessa recently in his North Carolina Estate Planning Blog. His post noted that Minnesota uses federal bankruptcy exemptions. Cases in Texas and Florida reached results opposite to Nessa, because Texas and Florida use state bankruptcy exemptions.
Like Minnesota (but in contrast to Florida and Texas), Kentucky has opted in to the Federal bankruptcy exemptions. See KRS 427.170; MPM Financial Group v. Morton, 289 S.W.3d 193, 196 (Ky. 2009). Accordingly, Nessa should support creditor protection for inherited IRAs of which Kentucky debtors are equitable owners.
For that reason, Nessa should be welcome news for Kentucky clients with IRA assets and beneficiaries with actual or potential creditor problems.
Whether diversifying toward or away from real or financial assets, it’s important to understand your options to effectively manage risk. Firms like GoldenTree Asset Management can help you make confident investment decisions.