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Inherited IRAs Not Exempt From Bankruptcy Estate Under New York Law

By Rudolph J. Di Massa, Jr. and Catherine B. Heitzenrater
November 15, 2018
The Legal Intelligencer

Inherited IRAs Not Exempt From Bankruptcy Estate Under New York Law

By Rudolph J. Di Massa, Jr. and Catherine B. Heitzenrater
November 15, 2018
The Legal Intelligencer

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photo of Rudolph J. Di Massa, Jr.

Rudolph J. Di Massa, Jr.

photo of Catherine Beideman Heitzenrater

Catherine B. Heitzenrater

In a matter of first impression, the U.S. Bankruptcy Court for the Northern District of New York recently analyzed whether a debtor may exempt from her bankruptcy estate a retirement account that was bequeathed to her upon the death of her parent. In In re Todd, 585 B.R. 297 (Bankr. N.D.N.Y 2018), the court addressed an objection to a debtor’s claim of exemption in an inherited retirement account, and held that the property was not exempt under New York and federal law. In ruling for the objecting creditor, the court analyzed New York law, the Internal Revenue Code and the Bankruptcy Code, none of which provided a basis to exempt the inherited retirement account from the debtor’s bankruptcy estate. The court also noted that inherited IRAs are treated differently under applicable law, and are subject to additional limitations, than are traditional IRAs.

Facts and Arguments of the Parties

Before filing for bankruptcy protection, Laurie Todd and her family were involved in a construction business. In the course of running that business, various family members entered into an indemnity agreement with a surety company that issued payment and performance bonds on behalf of the family’s construction company. Pursuant to these bonds, the surety company made substantial payments to various claimants, and sued Todd and other family members in state court to enforce its indemnity rights.

Consequently, Todd filed for bankruptcy protection. In her schedules, she listed as exempt an individual retirement account, with an approximate book value of $800,000, that she had inherited from her mother. In the meantime, the surety company filed a proof of claim in Todd’s bankruptcy case in the amount of $1,769,317, and also objected to Todd’s claim that the inherited IRA was an exempt asset.

There was no dispute between the parties that the funds in the inherited IRA were all amounts that the debtor had inherited from her mother. The debtor did not make any personal contributions to the inherited IRA, nor would she have been permitted under federal law to do so. Nevertheless, the debtor asserted that the inherited IRA was exempt from her estate: as a “trust” pursuant to New York Civil Practice Law and Rules Section 5205(c)(1); as a “qualified” IRA pursuant to N.Y. C.P.L.R. Section 5205(c)(2); and as a spendthrift trust under Section 541(c)(2) of the Bankruptcy Code. In opposition, the creditor argued that the inherited IRA: was not exempt under N.Y. C.P.L.R. Section 5205(c)(1), because the property was not held in trust for the debtor; was not exempt pursuant to N.Y. C.P.L.R. Section 5205(c)(2) because it was not a “qualified” IRA under the Internal Revenue Code; and constituted property of the estate pursuant to the Bankruptcy Code.

The Court’s Analysis

The court addressed each of these arguments in turn, and ruled in favor of the creditor in each instance. The court first examined whether the inherited IRA could be considered a trust under N.Y. C.P.L.R. Section 5205(c)(1), and thus exempt from the debtor’s bankruptcy estate. In its analysis, the court noted that the N.Y. C.P.L.R. Section 5205(c)(1) exemption is unavailable where the debtor has actual control over the funds in an account and may use the funds without restriction. Noting that the debtor: had actual and exclusive control over the funds in the account; could withdraw funds from the account at any time; and had, in fact, been withdrawing funds from the account during the course of her bankruptcy case, the court ruled that the N.Y. C.P.L.R. Section 5205(c)(1) exemption was unavailable to the debtor.

The court next addressed whether the inherited IRA was exempt under N.Y. C.P.L.R. Section 5205(c)(2) as an account “qualified as an individual retirement account” under Section 408 of the Internal Revenue Code. The court found N.Y. C.P.L.R. Section 5205(c)(2) to be ambiguous with respect to both the term “qualified” and the term “individual retirement account,” because neither term is defined in the statute, and each is subject to more than one reasonable interpretation. The court also noted that although the Internal Revenue Code defines “individual retirement account,” it does not define the term “qualified.” It concluded that the phrase “qualified as an individual retirement account” was susceptible to more than one reasonable interpretation and was, as a result, ambiguous.

Accordingly, the court turned to the legislative history of N.Y. C.P.L.R. Section 5205(c)(2) to determine the intent of the legislature with respect to what types of accounts were intended to be “qualified” for exemption purposes under that section.  In reviewing the legislative history, the court found that in enacting N.Y. C.P.L.R. Section 5205(c)(2), the state legislature was reacting to bankruptcy court decisions holding that various types of retirement accounts were estate property and were therefore available to repay creditors. After these decisions were entered, the legislature amended N.Y. C.P.L.R. Section 5205(c)(2) on more than one occasion with an eye toward reducing the chance that an individual’s retirement savings would be administered in bankruptcy cases in New York. The court therefore found that the intention of the New York legislature was to protect an individual’s own retirement savings, and that it would be fundamentally inconsistent with the statute’s intent to similarly protect inherited IRAs under this provision. Finally, the court noted that other state legislatures had explicitly exempted inherited IRAs from Bankruptcy Code reach; it concluded that the New York legislature could very well have drafted explicit language had the legislature intended to allow for such an exemption.

Finally, the court briefly addressed the debtor’s argument that the inherited IRA was exempt as a spendthrift trust pursuant to Bankruptcy Code section 541(a). The court opined that in order for the inherited IRA to be exempted under Section 541(a), the IRA must have been deemed to be exempt under either N.Y. C.P.L.R. Sections 5205(c)(1) or (2). Because the court had already determined these C.P.L.R. sections to be unavailing, any exemption under Bankruptcy Code Section 541(a) failed as well.

Based on this analysis, the court held that the inherited IRA was property of the debtor’s estate and that, as such, the inherited IRA could be administered by the debtor’s trustee for purposes of paying estate creditors.


Although an inherited IRA does retain some of the legal benefits of an IRA held by the retiree, exemption from a bankruptcy estate is not one of those retained benefits unless it is so provided under state law. Both debtors and creditors should be aware of applicable state’s law on this issue; as turned out to be the case in Todd, the analysis and resulting decision regarding exemption of an IRA can have a significant impact on creditor recovery.

Rudolph J. Di Massa, Jr., a partner at Duane Morris' Philadelphia and New York offices, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Catherine B. Heitzenrater, an associate at Duane Morris' Philadelphia office, practices in the areas of bankruptcy, corporate reorganization, creditors’ rights, commercial finance and secured transactions. 

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.