Let’s say
that you divorce. Let say that retirement savings are unequal between you and your
ex-spouse. As part of the settlement you receive a portion of your spouse’s
401(k) under a “QDRO” order.
COMMENT: A QDRO is a way to get around the rule prohibiting alienation or assignment of benefits under a qualified retirement plan. I generally think of QDROs as arising from divorce, but they could also go to a child or other dependent of the plan participant.
Your QDRO has
(almost) the same restrictions as any other retirement savings. As far as you
or I are concerned, it IS a retirement account.
You file for
bankruptcy.
Can your
creditors reach the QDRO?
Sometimes I
scratch my head over bankruptcy decisions. The reason is that bankruptcy –
while having tax consequences – is its own area of law. If the law part pulls a
bit more weight than the tax part, then the tax consequence may be nonintuitive.
Let’s segue
to an inherited IRA for a moment. Someone passes away and his/her IRA goes to
you. What happens to it in your bankruptcy?
The Supreme
Court addressed this in Clark, where
the Court had to address the definition of “retirement funds” otherwise
protected from creditors in bankruptcy.
The Court
said there were three critical differences between a plain-old IRA and an
inherited IRA:
(1) The holder of an inherited IRA can never add
to the account.
(2) The holder of an inherited IRA must draw money
virtually immediately. There is no waiting until one reaches or nears
retirement.
(3) The holder of an inherited IRA can drain the
account at any time – and without a penalty.
The Court
observed that:
Nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after bankruptcy proceedings are complete.”
The Court continued
that – to qualify under bankruptcy – it is not sufficient that monies be inside
an IRA. Those monies must also rise to the level of “retirement funds,” and –
since the inheritor could empty the account at a moment’s notice - the Court
was simply not seeing that with inherited IRAs.
I get it.
Let’s switch
out the inherited IRA and substitute a QDRO. With a QDRO, the alternate payee
steps into the shoes of the plan participant.
The Eighth
Circuit steps in and applies the 3-factor test of Clark to the QDRO. Let’s walk through it:
(1) The alternate payee cannot add to a QDRO.
(2) The alternate payee does not have to start
immediate withdrawals – unless of required age.
(3) The alternate payee cannot – unless of
required age - immediately empty the account and buy that vacation home or
sports car.
By my account,
the QDRO fails the first test but passes the next two. Since there are three
tests and the QDRO passes two, I expect the QDRO to be “retirement funds” as
bankruptcy law uses the term.
And I would
be wrong.
The Eighth
Circuit notes that tests 2 and 3 do not apply to a QDRO. The Court then concludes
that the QDRO has only one test, and the QDRO fails that.
The Eighth
Circuit explains that Clark:
… clearly suggests that the exemption is limited to individuals who create and contribute funds into the retirement account.”
It is not
clear to me, but there you have it – at least if you live in the Eighth
Circuit.
No
bankruptcy protection for you.
Our case
this time for the home gamers was In re
Lerbakken.
