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Are Funds Received as the Beneficiary of an IRA Property of the Estate in Bankruptcy?

IRA BeneficiaryWhen an individual files a Chapter 7 bankruptcy case, the debtor’s non-exempt assets become property of the estate that is used to pay creditors. “Property of the estate” is a defined term under the Bankruptcy Code, so a disputed question in many cases is: What assets are, in fact, available to creditors?

In a recent case in the U.S. Bankruptcy Court for the Eastern District of Michigan, the court considered whether money received by a Chapter 7 debtor pursuant to an IRA beneficiary designation signed by her deceased mother, constitutes property of the estate.[1] As discussed below, the court ruled in favor of the debtor, finding that the transferred IRA funds were not property of the estate.

The issue came before the court after the Chapter 7 trustee, upon learning of the receipt of IRA funds by the debtor, sought to reopen the case and compel the turnover of the funds to the estate. The debtor objected, briefs were submitted, and the court ruled.

Funds Transferred to Debtor as IRA Beneficiary are not Property of the Estate

The trustee argued that the funds received from the debtor’s mother’s IRA constituted property of the estate under Sections 541(a)(5)(A) and (C) of the Bankruptcy Code, which include property received “by bequest, devise, or inheritance” or as “a beneficiary of a...death benefit plan.”

Because those terms are not defined by the Bankruptcy Code, the court relied on state law to determine whether the IRA transfer falls within their meanings. Turning first to an analysis of the meaning of “by bequest, devise, or inheritance” under Section 541(a)(5)(A), the court determined that for the funds received by the debtor from her mother’s IRA to become property of the estate, they must have been received “as part of a testamentary disposition or by intestate succession.” (In other words: received by will or from ancestors under the laws of intestacy).

The court explained that the funds were not received by bequest, devise, or inheritance and thus were not property of the estate. Rather, the funds were distributed by contract pursuant to the beneficiary designation.

In addition, the trustee argued that the IRA at issue was a “Totten trust” which, according to the trustee, is a testamentary instrument that constitutes a will. The court noted that some courts do view Totten trusts as testamentary instruments while others do not. However, determining whether funds passed to a debtor via a Totten trust constitute property of the estate did not need to be analyzed because, according to the court, the IRA was a payable on death account, not a Totten trust. The debtor received the funds because of the beneficiary designation in her mother’s IRA. Pursuant to Michigan state law, a transfer on death under a beneficiary designation “is effective by reason of contract...and is not testamentary.” The funds were not passed by a testamentary instrument and, therefore, were not property of the estate under Section 541(a)(5)(A).

Finally, the court considered whether the funds were property of the estate because they were received by the debtor as “a beneficiary of a...death benefit plan” under Section 541(a)(5)(C). In ruling that the debtor was not “a beneficiary of a...death benefit plan,” the court noted that such a plan provides a benefit “connected to or arising out of one’s employment.” An IRA, on the other hand, can be established by anyone and is not connected to employment.

The court rejected each of the trustee’s arguments in support of the motion to compel turnover of funds, ruling that the IRA funds were not property of the estate pursuant to Sections 541(a)(5)(A) and (C) of the Bankruptcy Code.

If you have further questions related to this case or other bankruptcy questions in general, contact Patricia Scott at 517.371.8132 or at pscott@fosterswift.com.

[1] In re Angela M. Neubert, Case No. 20-30771-jda (E.D. Bank., Decided Nov. 25, 2020).

Categories: Chapter 7, Eastern District of Michigan, Estate Planning

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