Ex-Spouse’s Retirement Funds May Not Receive Bankruptcy Protection

While the IRS allows distributions from a former spouse’s retirement account to be rolled over into a traditional IRA, two conditions apply.

First, it must be an “an eligible rollover distribution ... if it had been made to the employer.” Second, it must be made under a qualified domestic relations order (QDRO). If these conditions are not met, the funds may not receive protection from creditors in the advent of bankruptcy.

Both played a role in an appeals court ruling on the subject.

The appellant, Brian Lerbakken, had been awarded one-half the value of his ex-wife’s 401(k) account and an entire individual retirement account (IRA) of hers as part of a property settlement. The state court’s order dissolving the marriage required Lerbakken to submit a QDRO; he refused. Because there was no QDRO, the ex-husband could not enforce his interest in the 401(k), thereby disqualifying its characterization as retirement funds.

Secondly, Lerbakken failed to rename or transfer his ex-wife’s IRA into an account under his name. This mattered because it made the IRA in question subject to “a condition not performed.” Citing a prior case, Judge Duane Benton wrote, “[Bankruptcy] exemptions are ‘not of property which would or might be exempt if some condition not performed were performed, but of property to which there is ... a present right of exemption’ … When Lerbakken filed for bankruptcy on January 23, 2018, his interest in his ex-wife’s IRA was subject to a condition not performed—it had not been renamed, or transferred into an account under his name.”

Justice Benton cited the U.S. Supreme Court’s ruling in Clark v. Rameker in his opinion. (See the July 2014 AAII Journal Dispatch, “Supreme Court: No Bankruptcy Protection for Inherited IRAs.”) Under the standards set in Clark, the funds received by Lerbakken in the divorce were not “funds objectively set aside for retirement.” Not only had he not rolled over the IRA, but a Minnesota bankruptcy court obligated Lerbakken to use the funds in the account to pay his divorce attorney.

Sources: “Brian A. Lerbakken v. Sieloff and Associates, P.A.,” U.S. Bankruptcy Appellate Panel for the Eighth Circuit, No. 18-6018, October 16, 2018; “Brian A. Lerbakken v. Sieloff and Associates, P.A.,” U.S. Court of Appeals for the Eighth Circuit, February 7, 2020; IRS Publication 590-A, “Contributions to Individual Retirement Arrangements (IRAs).”