When a couple divorce, it is not uncommon for one partner to have accumulated significantly larger retirement accounts (e.g., in 401(k) plans or IRAs) than the other. In such cases the parties generally divide IRA accounts pursuant to Internal Revenue Code 408(d)(6) and/or enter into a qualified domestic relations order (QDRO) to divide a 401(k) or other qualified retirement plan.
The importance of moving promptly to divide and transfer title to retirement accounts in divorce was highlighted in a Bankruptcy Court case from 2018, In re Lerbakken, 590 B.R. 895 (8th Cir. 2018). In the case, the husband’s failure to take formal legal custody of half of his ex-wife’s 401(k) account (through obtaining a QDRO), and the entirety of one of her IRAs, resulted in those amounts becoming available to creditors in the husband’s bankruptcy case.
In Lerbakken, the court’s dissolution order/property settlement directed Lerbakken’s attorney to submit a QDRO with respect to the 401(k) account, and presumably contained language relevant to transferring title to the IRA, for which a QDRO is not necessary. However no steps towards obtaining a QDRO or transferring title of the IRA were taken. When Lerbakken filed a voluntary Chapter 7 bankruptcy petition, he claimed his share of the 401(k) account, and the IRA, as exempt retirement accounts. The bankruptcy court disallowed the exemption on the basis of the Supreme Court’s opinion in Clark v. Rameker, 134 S.Ct. 2242 (2014), which held that a non-spousal inherited IRA (in that case, from a mother to a daughter) was not entitled to the same protection from bankruptcy creditors as are retirement funds that are individually set aside by the person claiming bankruptcy protection; e.g. inherited accounts are more in the nature of a financial windfall than an intended source of retirement living expenses.
On appeal, the Bankruptcy panel of the 8th Circuit court agreed, noting that Clark v. Rameker limits the bankruptcy exemption to “individuals who create and contribute funds into the retirement account,” and disregarding Lerbakken’s claim that he would use the funds for retirement income. The court’s final summing up suggests that a different result would have obtained, had Lerbakken obtained a QDRO and moved the IRA funds into his own name, rather than simply having relied on the wording of the property settlement:
“We recognize that Lerbakken’s interest in the 401(k) and IRA did not arise in the identical manner as the IRA account addressed in Clark. This distinction is not material to our de novo review. Any interest he holds in the Accounts resulted from nothing more than a property settlement. Applying the reasoning of Clark the 401(k) and IRA accounts are not retirement funds which qualify as exempt under federal law.” (Emphasis added.)
In essence, the result is that without having taken actual ownership to the retirement funds, Lerbakken could not “borrow” the exemption status for the 401(k) and IRA that his wife would have been able to claim, had she been the bankruptcy debtor. The fact that Lerbakken himself may have been saving money during the marriage to allow for his ex-wife’s 401(k) and IRA contributions simply does not come into play. The Lerbakken opinion did not address the question of how one of Lerbakken’s creditors (who included his family law counsel) would actually obtain the assets still held in the ex wife’s 401(k) account and IRA, but presumably they would intervene in any attempt to later transfer these amounts over to Lerbakken or to accounts established on his behalf.
As legal precedent, the Lerbakken ruling is limited to states in the 8th Circuit, namely Arkansas, Iowa, Minnesota, Missouri, Nebraska, and North and South Dakota, but it’s invocation of the Supreme Court’s Clark v. Rameker decision could be invoked in other districts. It is also possible that this concept could influence state courts deciding the rights of non-bankruptcy creditors. It therefore provides a timely reminder of the importance of moving promptly to obtain a QDRO and to move IRA assets pursuant to Internal Revenue Code 408(d)(6) pursuant to divorce. Sitting on your rights in such instances could result in loss of the protected status of retirement savings in a bankruptcy or possibly other creditor situation.
The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2019 Christine P. Roberts, all rights reserved.