By John C. Rogers, Attorney, Incline Law Group
This question is important to those who receive an IRA as a beneficiary, but more important to those who plan to pass an IRA to children or other beneficiaries. The latter have the opportunity to plan so that the inherited IRA includes protection from creditors.
In a recent landmark decision, the U.S. Supreme Court held that an inherited IRA does not qualify for the “retirement funds” exemption under the bankruptcy code Clark v. Rameker, 573 U.S. ___ (2014).
In that case, IRA beneficiaries filed for Chapter 7 bankruptcy protection and claimed about $300,000 in an inherited individual IRA as exempt “retirement funds.” (See 11 U. S. C. Sec. 522(b)(3)(C).)
The court decided that funds in an inherited IRA were not “retirement funds” intended to be protected by the exemption.
The court pointed to three legal characteristics of inherited IRAs that clearly distinguished them from protected “retirement funds.” (1) Inherited IRAs can never be increased by contributions from the inheriting holder. (2) Holders of an inherited IRA must withdraw funds from the account no matter how far they are away from retirement. And finally, (3) the holder may withdraw the entire balance of the account at any time, for any purpose, without penalty.
The policies that allow original IRA holders to exempt “retirement funds” from the reach or creditors help assure that IRA funds will be available to fund necessities during retirement years. Because of the distinguishing characteristics described above, an inherited IRA operates in opposition to those policies.
If you are the holder of an IRA and you anticipate naming children or others as beneficiaries, and if you want to provide creditor protection for those beneficiaries, there are a number of mechanisms that may achieve this goal.
If you already hold an inherited IRA, you may want to consult with an attorney regarding the pros and cons of liquidating that IRA and investing in other protected assets.