Court Decides that Bankruptcy Creditors Cannot Touch Inherited 401(k) Funds

Ian Berger, JD
IRA Analyst
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Suppose you inherit 401(k) (or other ERISA plan) funds and then file for bankruptcy before receiving those funds. Can you lose those 40(k) dollars to your bankruptcy creditors? According to a recent decision of a Bankruptcy Court in North Carolina, you don’t have to worry.

In the case of In re: Dockins, No. 20-10119 (Bankr. W.D.N.C. June 4, 2021), Kirk Morishita, an employee of Wells Fargo Bank, designated his then-girlfriend, Holly Corbell, as beneficiary of his 401(k) account. The relationship did not last, and several years later, Holly married Chris Dockins.

In February 2020, Kirk died while still employed at Wells Fargo and with Holly still as his 401(k) beneficiary. Wells Fargo set up a 401(k) account in Holly’s name with a value of over $35,000. The Dockinses then filed for bankruptcy and excluded the $35,000 from the property that was available to their creditors. The bankruptcy trustee went to court to challenge the exclusion of the inherited 401(k).

The judge had to decide which of two U.S. Supreme Court decisions takes precedence when someone inherits 401(k) funds. In the 1992 Patterson v. Shumate case, the Supreme Court decided that retirement benefits covered by ERISA are shielded from creditors in a bankruptcy. [Most 401(k) plans, and some 403(b) and 457(b) plans, are ERISA plans. IRAs are not covered by ERISA.] Bankruptcy protection results from an ERISA requirement that ERISA plans cannot pay benefits to anyone other than a participant or a beneficiary.

But in the 2014 Clark v. Rameker case, the Supreme Court said that inherited IRA funds are not protected from bankruptcy creditors. The Court reasoned that only “retirement funds” are protected, and inherited IRAs are not “retirement funds” because they are normally paid soon after death – not when the beneficiary retires.

The Bankruptcy Court decided to follow the Patterson decision, not the Clark decision. The Wells Fargo plan is an ERISA plan – not an IRA. As required under ERISA, the Wells Fargo plan provided that “your 401(k) Plan account cannot be reached by creditors either by garnishment or any other process. Also, you may not pledge or assign your 401(k) Plan account to anyone else.” For that reason, the Dockinses get to keep Holly’s $35,000 inherited 401(k) dollars.

The Bankruptcy Court cautioned, however, that the result would have been different if Holly had withdrawn the account before she and her husband filed for bankruptcy. Inherited ERISA plan dollars are shielded only if the funds remain in the plan when the bankruptcy filing takes place.

Keep in mind that this is only one decision from one judge. It is entirely possible that other courts could rule differently. However, if you have inherited retirement funds and are considering bankruptcy, be aware that at least one judge has distinguished between inherited ERISA plan benefits and inherited IRAs.