On June 12, 2014, the United States Supreme Court unanimously ruled that Inherited IRAs are not exempt in bankruptcy.
The United States Supreme Court, in the case of Clark v. Rameker, ruled that Inherited IRAs enjoy no special protection in bankruptcy, unlike IRAs created and funded by the debtor. Even though the Bankruptcy Code exempts qualified retirement plans, IRAs and similar "retirement funds," the Court decided that this bankruptcy exemption for retirement funds does not extend to an Inherited IRA.
Inherited IRAs represent funds left by a deceased IRA owner for a spouse, child or other "inheritor." Inherited IRAs are becoming a more significant portion of taxpayers' net worths, as they inherit their parents' retirement accounts. Many people who receive these retirement benefits hold them in Inherited IRAs in order to take "stretch" distributions from the Inherited IRAs over their remaining life expectancy. With the Clark decision, these Inherited IRAs are now at full risk of being taken by bankruptcy creditors.
Several steps can be taken in order to protect assets from bankruptcy creditors of the inheritor, whether those inheritances are in the form of IRAs or other assets. Surviving spouses, for example, should almost always make a "rollover" of IRAs received from their deceased spouse instead of simply taking withdrawals from the deceased spouse's Inherited IRA. When a surviving parent leaves retirement funds to children at his or her death, that parent should consider leaving the retirement funds to an "Inherited IRA Beneficiary Trust," rather than directly to the child. The Inherited IRA Beneficiary Trust can be designed to retain the "stretch" distribution payout from the IRA while protecting the assets from bankruptcy creditors.
Alternatively, a participant who has a balance in a qualified retirement plan may choose to leave the balance in the qualified retirement plan, and then leave the retirement plan balance to his or her beneficiaries after death. "Inherited" retirement plan balances may enjoy greater bankruptcy protection than Inherited IRAs now receive.
People with significant balances in their retirement accounts who wish to protect their children's inheritance of those retirement accounts should consider updating their estate plan, and should consider using an Inherited IRA Beneficiary Trust as part of that planning. Please contact your Reinhart Trusts and Estates attorney or your Reinhart attorney to discuss how this new ruling may impact you and your family.