Immediately upon filing a petition for relief under title 11 of the United States Code (the “Bankruptcy Code”), a bankruptcy estate is created by operation of law that consists of the debtor’s assets from which the creditors will be repaid. The Bankruptcy Code states that the estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” This broad language reflects Congress’s intent that there be sufficient assets in the estate to protect the interests of creditors.
Despite this broad legislative language, there are certain categories of property that the debtor may retain possession of and does not become part of the bankruptcy estate. One such category, known as exempt property, does not become property of the estate if the debtor asserts the applicable exemption with respect to that property. One such exemption allows for a debtor to retain “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.”
A second category of property that does not go into the bankruptcy estate is described in section 541(c)(2) of the Bankruptcy Code. The section states “[a] restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” If the retirement account in question is subject to a transfer restriction “under applicable nonbankruptcy law,” then the debtor may keep the account without needing to claim an exemption.
These rules do not provide any qualifying language regarding the source of the retirement account thus raising the issue as to the applicability of these rules to a retirement account that is inherited by a debtor. First, this memorandum outlines the necessary elements for the successful use of a section 522(b)(3)(C) exemption for inherited retirement accounts. Second, this memorandum clarifies which laws are included in “applicable nonbankruptcy law,” and may thus serve as the source of a transfer restriction for the purpose of excluding an inherited retirement account from the bankruptcy estate under section 541(c)(2). The final section of the memorandum explains that an inherited retirement account may be retained by a debtor if it is subject to a transfer restriction under “applicable nonbankruptcy law,” even if the account would not qualify for an exemption.