Creditor Protection Denied for Florida Debtor’s Inherited IRA

KYEstates has been following issues of creditor protection for inherited IRAs closely (see here and here), and we haven’t hidden the fact that on this issue, we’re biased in favor of the debtor. Before today, our series was tied at Debtor 1, Creditor 1. With today’s report, the score regrettably changes to Debtor 1, Creditor 2. The bad news comes in the form of Robertson v. Deeb, 16 So.3d 936 (Fl. Dist. Ct. App. 2 Dist. 2009), a pro-creditor decision that illustrates the risks facing beneficiaries of inherited IRAs seeking creditor protection for their accounts.

To recap:  Nessa and Chilton both involved fact patterns similar to those of Robertson: a debtor inherited an IRA and sought protection for the account against the claims of their creditors. Nessa (a debtor win) involved a Minnesota debtor and federal exemptions, because Minnesota is a an “opt-in” state. (Kentucky is also an “opt-in” state.) Chilton (a creditor win) involved a Texas debtor and federal exemptions, because Texas allows a debtor to choose between federal and state exemptions, and the Chilton debtor had elected federal exemptions. Because Florida is an “opt-out” state, Robertson involved Florida state exemptions.

If a creditor attempts to take assets in an inherited IRA owned by one of your clients, they will surely cite Robertson and for that reason, even if KYEstates doesn’t like the case or its holding), we should review it carefully. 

In Robertson, the account holder (Robertson) was sued by Deeb (payee under a promissory note made by Robertson).  The creditor obtained a judgment and served a write of garnishment on RBC Wealth Management, custodian of the debtor’s inherited IRA.  The debtor filed a claim of exemption and argued that the IRA, which the debtor had inherited from his father, was exempt from garnishment under F.S. 222.21(2)(a). [For more on Florida asset protection, consult this KYEstates chart.]

Even though F.S. 222.21(2)(a) protects “money or other assets payable to an owner, a participant or a beneficiary” in a fund or account that is maintained as an IRA pursuant to a plan or governing instrument that is exempt from taxation under certain provisions of the Internal Revenue Code, the trial court found that this statutory protection does not extend to an inherited IRA, and denied the debtor’s claim of exemption.

The Second District Court of Appeals upheld the trial court, concluding that F.S. 222.21(2)(a) “does not apply to inherited IRAs because the plain language of that section references only the original ‘fund or account’ and the tax consequences of inherited IRAs render them completely separate funds or accounts.”

Somewhat surprisingly, rather than closely interpreting and carefully applying the applicable Florida statute, the appeals court chose instead to rely heavily on In re Sims, 241 B.R. 467 (Bankr.N.D.Okla. 1999), a case applying Oklahoma state law. Following Sims, it noted that:

…unlike original IRAs, inherited IRAs are not vehicles to defer taxation on income in order to preserve money for retirement. Instead, inherited IRAs are liquid assets that the beneficiary may access at any time without penalty and that the beneficiary must take as income without regard to retirement needs.

Even more surprisingly, the Florida appeals court cited Sims‘s analysis of the Oklahoma legislature’s legislative intent:

The purpose of the … Legislature in exempting individual retirement accounts is to allow debtors to preserve assets which have been earmarked for retirement in the ordinary course of the debtor’s affairs. Such a purpose would not be served by upholding [the beneficiary’s] request to keep his interest in the IRA as exempt.

Even though the Florida debtor might justifiably have thought Oklahoma law wouldn’t apply to him — because he didn’t live in Oklahoma — the Florida appeals court declared that “[w]e find this reasoning persuasive and equally applicable to section 222.21(2)(a). Because the plain language of section 222.21(2)(a) references only the original ‘fund or account’ and the tax consequences of inherited IRAs like the one in this case render them a completely separate ‘fund or account,’ such inherited IRAs are not exempt under that section.”

Accordingly, the appeals court affirmed the order denying the debtor’s claim of exemption from garnishment.

In a recent newsletter by Steve Leimberg, Kristen M. Lynch and Linda Suzzanne Griffin (two noted Florida estate planning attorneys), explained why they believe Robertson was decided incorrectly.  First, they argue that survivor beneficiaries should be provided the same protection [under F.S. 222.21(2)(a)] as actual contributors, because the statute makes no distinction between the two.  Second, they note that Florida has a policy that favors liberal construction of exemption statutes to prevent debtors from becoming burdens to the public. Goldenberg v. Sawczak, 791 So.2d 1078, 1081 (Fla. 2001).  Third, they note that Section 402(c)(11) of the Internal Revenue Code provides that a transfer to an inherited IRA is an eligible rollover, and that the exemption under F.S. 222.21(2)(c) remains available for eligible rollovers or transfers [under section 402(c)(11)].

Robertson is a threat similar to the threat posed by Chilton.  Given those threats, and given the risk that a court will not follow Nessa, the case is strong for clients with substantial IRA assets and beneficiaries that have (or may have – and isn’t that all of us?) creditor protection concerns to designate an accumulation trust as beneficiary of their IRA, instead of designating beneficiaries outright.  The accumulation trust would feature spendthrift protections and would be drafted to permit use of the beneficiary’s (presumably longer) life expectancy as the measuring life against which required minimum distributions are taken from the IRA.

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