Does the Oregon Retirement Exemption Already Effectively Overturn the U.S. Supreme Court’s Ruling Limiting the IRA Exemption?

Last month the Supreme Court said inherited Individual Retirement Accounts are not protected in bankruptcy. Oregon says maybe they are.

On June 12, 2014 all nine justices of the United States Supreme Court said in Clark v. Rameker

that an IRA that is transferred to a beneficiary by death of the original owner is no longer protected from creditors. Instead of being fully exempt and thus kept in the hands of the owner—just like a regular IRA or just about any other kind of retirement fund—it is treated the same as cash or a bank account and must be given to the bankruptcy trustee for distribution to the creditors.

Ways Around the Supreme Court Ruling

The Supreme Court has spoken, and that is the law of the land. But only as far as it goes. There are a number of possible ways around this result.

One possible way is through state exemption laws, either already on the books or written specifically to get around this ruling. States can—under many situations—be more generous in protecting what a person filing bankruptcy can protect from creditors.

But Bankruptcy Is Federal Law, So How Can Oregon Trump Bankruptcy Law?

True. The Supremacy Clause of the U.S. Constitution says that when there is a direct conflict between federal law and state law on a subject within the legitimate power of the federal government, federal law “preempts” state law. The U.S. Constitution and federal laws “shall be the “supreme law of the land.”

But federal law itself, right in the Bankruptcy Code, explicitly ALLOWS state exemptions to be used instead of the federal ones. In fact, bankruptcy law allows states to INSIST that their residents use that state’s exemptions instead of the federal ones. Oregon did so for decades until a year ago when it started allowing its residents to use either the federal exemptions or the ones provided in Oregon law. In any event, if you file a bankruptcy now in Oregon, you get to choose which set of exemptions to use (although you can’t pick and choose some exemptions from one set and others from the other set).

The Supreme Court Ruling Was About an Extra State Retirement Exemption

When Congress last significantly revised the Bankruptcy Code in 2005, it created a federal retirement exemption protecting “[r]etirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section . . . 408 . . . of the Internal Revenue Code.” That is, “retirement funds” in an IRA are exempt for people filing bankruptcy and choosing the federal set of exemptions.

Congress used this exact same language as well in the part of the Bankruptcy Code permitting the use of state exemptions. It presumably did so to make sure that a person filing bankruptcy anywhere in the country would have at least that much protection for his or her retirement money, regardless whether state law provided a retirement exemption or not.

It was this state version of the “retirement funds” language that the Supreme Court interpreted to say an inherited IRA does not constitute “retirement funds.”

So if a state chose to provide a stronger or broader exemption than provided through this “retirement funds” language, people in that state would be able to use the state’s better exemption. This should be clear from the way Congress structured the statute. It said that a person filing bankruptcy “may exempt . . . the property listed in” a part of the Code referring to the state exemptions. The state part of the Code includes both any retirement that the person has which is “exempt under . . . State or local law . . . AND those exempt as “retirement funds [in an IRA].”

In other words, whatever protection Oregon law gives to retirement money, it would supplement whatever protection is provided under the Bankruptcy Code’s “retirement funds” language. So, if Oregon law exempts inherited IRAs, then a person could use that Oregon exemption for that purpose, even now that the U.S. Supreme Court has decided that “retirement funds” does not include inherited IRAs.

Does Oregon Law Protect Inherited IRAs?

Some state’s laws specifically say that inherited IRAs are exempt. For example, in 2013 North Carolina’s state exemption was expanded to include inherited IRAs, in other words those held by beneficiaries after death of the original owner. The North Carolina statute now says that any “money or other assets . . . in [an IRA] plan remains exempt after an individual’s death if held by one or more subsequent beneficiaries.” That’s quite clear.

Oregon’s law is not quite as clear. It states that:

a retirement plan [including an IRA under section 408 of the Internal Revenue Code] shall be conclusively presumed to be a valid spendthrift trust under these statutes and the common law of this state . . ., and a beneficiary’s interest in a retirement plan shall be exempt . . . .

“Valid spendthrift trusts” are protected from creditors, so an IRA that is deemed by law to be a “valid spendthrift trust” is protected. Also, a person who owns an inherited IRA is under the law a beneficiary of the IRA, again making it appear that his or her interest in the IRA would be exempt.

But again, this Oregon statute is not like North Carolina’s and that of other states which were specifically changed recently to exempt inherited IRAs. So we have to admit that a court may or may determine that the Oregon exemption protects inherited IRAs.

The Oregon Legislature Should Clarify the Retirement Exemption

Congress and state legislatures often react to court interpretations or misinterpretations of their laws by passing new ones which correct or make clearer the “will of the people.” Last month’s Clark v. Rameker opinion by the U.S. Supreme Court gives the Oregon Legislature the opportunity to do this—to protect money in an IRA regardless whether it happens to be in the hands of the original owner or of the person to whom this retirement money was given when the original person died. Otherwise, the situation will remain ambiguous.