June 17, 2014
- Supreme Court Decision: Inherited IRAs Not Exempt from Debtor's Bankruptcy Estate
- Proposed Legislation Seeks to Protect Employee Benefits in Bankruptcy, Creates Presumption of Vesting for all Retiree Health Benefits
Supreme Court Decision: Inherited IRAs Not Exempt from Debtor's Bankruptcy Estate
In a unanimous decision handed down on June 12, the U.S. Supreme Court ruled that inherited IRAs do not qualify as “retirement funds” that are exempt from a debtor’s bankruptcy estate. This decision may have implications for retirement and estate financial planning.
In 2005, Congress amended the bankruptcy code to provide that “retirement funds” are exempt from a debtor’s bankruptcy estate “to the extent that those funds are in a fund or account that is exempt from taxation under certain sections of the tax code, including employer-sponsored retirement plans and IRAs. When an IRA owner dies, the IRA is categorized as an “inherited” IRA unless the beneficiary is the owner’s spouse. However, the 2005 changes to the Bankruptcy Code did not explicitly address whether an inherited IRA is entitled to the same exemption under the bankruptcy code that is available to retirement plans and non-inherited IRAs. Circuit courts have been unable to reach consensus on whether such inherited IRAs are exempt.
In the case of Clark v. Rameker, et al, the Supreme Court affirmed the conclusion and reasoning of the Seventh Circuit that the inherited IRA was not exempt from creditors under the bankruptcy code. To be exempt, the court ruled, two requirements must be met:
- The relevant funds must be “retirement funds.”
- Those funds must be held in an arrangement that is exempt from taxation under one of the enumerated sections of the Internal Revenue Code.
The Court consequently ruled that inherited IRAs are not “retirement funds,” based on three characteristics:
- the holder of an inherited IRA cannot make additional contributions to the account.
- the holder of an inherited IRA is required to withdraw money from the account no matter how close the holder is to retirement.
- the holder of an inherited IRA may withdraw the entire balance of the account at any time without imposition of the 10 percent penalty tax.
This is not the first time such issues have caught the eye of policymakers. Recent proposals in Congress and by the Obama Administration have sought to address “stretch IRAs,” which are broader than inherited IRAs and refer to instances where a non-spouse beneficiary elects a distribution of the remaining interest over his or her life or life expectancy. These “stretch IRA” proposals would amend the required minimum distribution rules for inherited IRAs to require faster payouts (and thereby limit tax deferral) for certain non-spouse beneficiaries. For more information, contact Jan Jacobson, senior counsel, retirement policy, at (202) 289-6700.
Proposed Legislation Seeks to Protect Employee Benefits in Bankruptcy, Creates Presumption of Vesting for all Retiree Health Benefits
The Bankruptcy Fairness and Employee Benefits Protection Act (S. 2418), introduced June 3 by Senators Jay Rockefeller (D-WV) and Elizabeth Warren (D-MA), would restrict companies from making changes to benefit programs in the event of bankruptcy. The bill also creates a presumption of lifetime vesting of retiree health benefits under ERISA plans and collectively bargained arrangements.
According to a news release and summary issued by Rockefeller’s office, “the bill would limit the ability of companies to reduce or terminate benefits for employees and retirees under the federal Bankruptcy Code, and entitle retirees to the continuation of health care benefits for at least two years following the restructuring of their former employer – even if the court rules that the company is eventually allowed to halt benefits.”
In addition, S. 2418 amends Section 502 of ERISA to establish a presumption that retiree health benefits under the plan fully vest at retirement or completion of 20 years of service and cannot be modified or terminated for the life of the employee or (if longer) the life of the employer’s spouse. In the event of litigation relating to the benefits of the retiree employee, this presumption could be overcome through the presentation of “clear and convincing evidence” that the group health plan allowed for modification or termination of benefits and “that the employee, prior to becoming a participant in the plan, was made aware, in clear and unambiguous terms” that the plan allowed for such modification or termination. ERISA currently does not provide for the vesting of retiree health benefits, unlike pension benefits.
Vesting of retiree health benefits is also under review by the U.S Supreme Court in M&G Polymers USA, LLC v. Tackett, a Sixth Circuit decision that applied an inference that union retiree benefits are intended to be vested in the absence of specific plan or bargaining agreement language to the contrary. Other appeals courts, including the Second, Third and Seventh Circuits, have ruled that retiree health benefits are not vested without specific durational language. As we reported in the May 6 Benefits Byte, the Supreme Court (in a decision next term) is expected to resolve a split among federal appeals courts regarding how to interpret collectively bargained agreements with respect to the duration of retiree health benefits.
S. 2418 would also:
- Require companies in bankruptcy to pay for retiree health care benefits for at least two years following the company’s restructuring.
- Require companies to continue making payments to pension plans while bankruptcy proceedings are ongoing.
- Require companies to provide specific information to employees about the duration of their retiree health care benefits.
- Commission a study by the Government Accountability Office (GAO) on strategies some companies use to avoid paying promised benefits to their employees and retirees.
An official section-by-section summary is also available on Rockefeller’s website.
The Council is concerned that the legislation, if enacted, would accelerate the decline in retiree health plan sponsorship by imposing significant restrictions on employers’ ability to modify retiree health benefits. While this legislation is unlikely to advance in Congress this year, it provides insight into potential legislative changes for employers to consider in their compliance planning and strategy with respect to retiree benefits.
For more information, contact Diann Howland, vice president, legislative affairs, at (202) 289-6700.