Inherited IRAs do not constitute “retirement funds” because the holder of an inherited IRA can never invest additional money into the account.
When Brandon and Heidi Heffron-Clark filed for Chapter 7 bankruptcy, they wanted to exclude $300,000 in an inherited individual retirement account (IRA) from the bankruptcy estate using the “retirement funds” exemption.
The did not want their creditors to use the IRA to pay off their debts. But in a decision on June 12, the U.S. Supreme Court ruled that that inherited IRA accounts are not “retirement funds” and are available to creditors in bankruptcy. The case is Clark v. Rameker, 13-299.
The issue in the case was a Bankruptcy Code provision, 11 U. S. C. § 522(b)(3)(C), that exempts “retirement funds” from a debtor’s bankruptcy estate.
The Supreme Court ruled that inherited IRAs do not constitute “retirement funds” because the holder of an inherited IRA:
- Can never invest additional money into the account.
- Is required to withdraw money from the account regardless of how far he or she is from retirement.
- May withdraw the entire balance of the account at any time, and use it for any purpose, without penalty.
Therefore, inherited IRAs are not covered by the Bankruptcy Code exemption even though they are exempt from current income taxation under Internal Revenue Code provisions.
TIPS TO PROTECT YOUR IRA
“This ruling will have a significant impact on an individual’s wealth preservation strategy. For many people, retirement accounts such as traditional IRAs, Roth IRAs and IRA Rollovers represent a substantial portion of their assets. Accordingly, protecting these accounts from the creditors of their beneficiaries is critical,” according to lawyers Devon MacWilliam and David Raymon of Partridge Snow & Hahn LLP.
Additionally, they advised:
- Alternative strategies should be explored in order to provide creditor protection for a non-spouse beneficiary of a retirement account. Naming a trust as the beneficiary of the retirement account instead of an individual can supply such creditor protection.
- Financial advisors should alert clients that it is now more important than ever to use trusts in conjunction with retirement accounts. Such trusts must be drafted carefully in order to preserve the income tax-favored treatment of an inherited IRA.
Settling opposite viewpoints
This case settled a split in the federal appeals courts. The Clark case was an appeal from a 7th Circuit decision that said inherited IRAs were not exempt from a debtor’s bankruptcy estate.
But the 5th Circuit (In re Chilton, 674 F.3d 486 (2012) and the 8th Circuit (In re Nessa, 426 B.R. 312 (2010) had previously taken the opposite videw. Both of those appeals courts ruled that inherited IRAs were exempt from a debtor’s bankruptcy estate as long as they were originally established as retirement accounts.
In upholding the 7th Circuit’s decision, the Supreme Court weighed the balance Congress established between creditors and debtors. Congress permitted an exemption for funds that a debtor would use to meet essential needs in retirement. However, the Court determined that exempting inherited IRAs from a bankruptcy estate would not further this goal.