Can a Debtor Exempt an Inherited IRA?

A person who has an Individual Retirement Account (IRA) may designate a beneficiary to receive the balance in the account if the person dies before the account is depleted. If the person dies before the funds are depleted, the beneficiary is now the owner of the account. Under Maryland exemption laws, a debtor, filing bankruptcy may exempt all the funds in his or her own IRA. The question arises whether a person, other than a surviving spouse, who inherits an IRA may also exempt all the funds in the inherited IRA.

The surviving spouse has the right to transfer the IRA to his or her own name. This is commonly referred to as a “rollover distribution.” Once this is done, the spouse’s IRA is exempt under Mayland law.

A nonspousal beneficiary does not have this option. Instead, the nonspousal beneficiary must keep the account in the deceased name and must take distribution of all the funds within either 5 years, or if an election is made, over the beneficiary’s life time. Neither type of beneficiary may make an contributions to the IRA, but both may withdraw the funds in the account without penalty even if he or she has not reached retirement age.

Courts split on whether the nonspousal beneficiary may exempt the IRA in a bankruptcy case. In one case, In re Nessa, 426 B.R. 312 (8th Cir. BAP 2010), the court allowed the exemption. While in the case of In re Chilton, 426 B.R. 612 (Bankr. E.D. Tex 2010), the court denied the exemption. However, in Maryland, the law specifically provides that:

“In addition to the exemptions provided..... any money or other assets
payable to a particiapant or beneficiary from, or any interest of any
participant or beneficiary in, a retirement plan qualfied under §401(a),
§403(a), §403(b), §408, .... of the United States Internal Revenue Code
...., shall be exempt from any and all claims of the creditors of the
beneficiary or participant...” (Emphasis supplied)

Accordingly, under Maryland exemption statute, the beneficiaries of an IRA, even a nonspousal beneficiary, should be able to exempt the IRA in their bankruptcy case.

Laura J. Margulies is a principal in the firm of Laura Margulies & Associates, LLC. Our web site is located at: www.law-margulies.com. We represent consumers in bankruptcy and litigation matters in Maryland and the District of Columbia.