The current bankruptcy code exempts retirement funds from creditors up to $1 million. The Supreme court has now determined that this exemption does not apply to an inherited IRA.
On June 12, 2014 the U.S. Supreme Court made it’s decision regarding whether or not inherited IRAs were protected from creditors and bankruptcy. The case stemmed from Clark v. Rameker, in which Heidi Heffron-Clark inherited an IRA account from her mother in 2001 and was forced to file for a Chapter 7 bankruptcy nine years later. Clark argued that the account consisting of $300,000, originally worth $450,000, should be shielded from her creditors using the “retirement funds” exemption.
IRA accounts are designed to ensure that the owner will have money for retirement, but according to the bankruptcy court, inherited IRAs loose this protection once handed over to the designated beneficiary. The District Court for the Western District of Wisconsin disagreed, arguing that the exemption covered any account in which funds are accumulated for retirement purposes. The 7th Circuit Court of Appeals agreed with the bankruptcy court and reversed the decision of the District Court. The U.S. Supreme Court affirmed the decision of the 7th Circuit Court of Appeals and the answer was clear: an inherited IRA account is NOT considered a “retirement funds” account and is NOT protected under Section 522(b)(3)(C), the current exemption section.
The Courts based their decision off of the fact that, unlike the original owner of the account, Clark could not contribute to an inherited IRA and on top of that, could begin taking withdraws at any time, regardless of how far away from retirement she actually was. Generally, beneficiaries are required to either begin taking withdraws from the IRA beginning December 31 of the year after the original owner’s death, or withdraw the entire balance within 5 years of the original owner’s death, without penalty.
But what about spousal inherited IRAs? The rules are a bit different for spouses because unlike a non-spousal beneficiary, a spouse has the option to “roll over” the account into his or her own IRA and can postpone distributions until age 70 1/2, or pay a 10% early withdraw penalty if taken before the age of 59 1/2. However, if the spouse does not opt for the “roll over” the account would then be considered an inherited IRA and although the spouse would not have to take distributions until the late spouse would have turned 70 1/2, the money would still not be protected from creditors and bankruptcy.
This case is important to take into account when thinking about asset protection and your beneficiaries. Talk to your attorney about how setting up and naming a Trust as your beneficiary, instead of a person, may help you protect your IRA assets and beneficiaries from creditors and bankruptcy.