Retirement accounts have traditionally been considered ‘exempt assets’ unavailable to creditors under the bankruptcy code in a chapter 7 bankruptcy. A recent decision by the 8th Circuit Bankruptcy Appellate Panel in In re Lerbakken puts this protection in jeopardy for spouses receiving retirement accounts in a divorce.
In Lerbakken, the husband received half of his ex-wife’s 401(k) in their divorce, which he transferred into his IRA. He later filed for bankruptcy and attempted to keep the IRA out of reach of his creditors as an exempt asset. The 8th circuit court found that the retirement funds he received in his divorce were not exempt assets under the bankruptcy code since he did not set aside these funds himself for his retirement. Since the funds were originally set aside by his wife for her retirement, they were not considered his ‘retirement funds’ under the bankruptcy code and not protected as exempt assets.
Although this ruling only applies to the jurisdiction of the 8th Circuit Bankruptcy Appellate Panel, which does not include Michigan, the case is worth watching as it may be an indication of the road ahead. If the logic of the case is followed by other jurisdictions, or upheld by the US Supreme Court, it could have disturbing implications for anyone receiving retirement assets in a divorce.
The US Supreme Court in Clark v. Rameker (2014) previously stripped the exempt asset status of retirement funds for beneficiary IRA’s. Since a beneficiary who inherits an IRA is not allowed to contribute additional funds into the inherited IRA, cannot roll it over into their own traditional IRA, and must start withdrawing money from the account after the death of the original owner, the court found inherited IRA’s were not within the definition of exempt ‘retirement funds’ as found in the bankruptcy code. As a result, a Standalone Retirement Trust may be the best option for a parent who wants to leave an IRA to a child who may have creditor issues to make sure that child gets the benefit of the IRA, rather than risk it is seized by his or her creditors.