The United States Supreme Court recently issued a 9-0 opinion holding that inherited IRAs are not exempt and protected from creditors in bankruptcy. As a general rule, IRAs receive special protections from creditors and cannot be reached by the creditors of the account owner. In Clark v. Rameker Trustee, Clark inherited her mother’s large IRA upon her mother’s death. Nine years later, Clark filed bankruptcy and sought to protect the inherited IRA from the reach of her own creditors. Under the bankruptcy code, “retirement funds” are protected from the reach of creditors and may generally be kept by the owner following bankruptcy. Justice Sotomayor, who wrote the opinion of the Court, wrote that inherited IRAs (not to include spousal inherited accounts) do not constitute “retirement funds” for three reasons. First, the owner cannot continue to contribute to the account. Inherited IRAs remain in the deceased owner’s name and cannot receive additional contributions from an heir. Second, the new owner is forced to take required minimum distributions from the account under a different set of rules than typical retirement accounts. And third, the account owner may withdraw the balance at any time without a 10% early withdrawal penalty. Because of these reasons the Court held that inherited IRAs are not “retirement funds” within the meaning of IRC 408 and as a result they are not protected from creditors. Consequently, the Clark’s entire inherited IRA is subject to the claims of creditors in bankruptcy.
In addition to the Court’s ruling in Clark, it is important to note three other facts regarding inherited retirement accounts and creditors.
- IRAs Inherited From a Spouse. When a surviving spouse inherits a retirement plan from a deceased spouse, the surviving spouse may simply roll over the deceased spouses account into an IRA owned by the surviving spouse and the retirement funds become a new account or add to an existing account of the surviving spouse. This is different from a non-spousal inherited account that was involved in the Clark case. Spousal inherited IRA funds go into the surviving spouses own IRA and are subject to the typical retirement plan rules. Because of this, inherited spousal retirement plans funds are different than that of non-spousal inherited funds and are not subject to the Court’s holding in Clark.
- Certain States Specifically Protect Inherited IRAs. When in bankruptcy a debtor can seek the protection of certain assets from creditors under federal exemptions and/or they can seek the protection of certain assets (such as IRAs) under the laws of their State. Under the laws of a few states, inherited IRAs are specifically protected from creditors and as a result the Court’s opinion in Clark would likely not apply. Those states include, Arizona, Texas, and Florida.
- Consider an IRA Trust For Large IRAs. If you have an estate comprised of significant IRA holdings, you may be able to establish a special IRA Trust, which can be used to shelter your IRA funds from your heir’s creditors. A trust should only be listed as a beneficiary of an IRA upon careful planning and consideration as the Trust needs to contain certain provisions in order to qualify as a valid trust under retirement plan rules.
Since inherited IRAs have special rules and procedures, it is recommended that person’s with large IRAs seek the guidance and assistance of an attorney in planning their estate and retirement fund’s future. Also, if you have an inherited IRA and are considering bankruptcy, stop, consult, and plan with the proper counsel lest you lose the account to creditors.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook