A unanimous Supreme Court decision in the Clark v. Rameker case has held that inherited IRAs do not qualify for a bankruptcy exemption, i.e., inherited IRAs are not protected from creditors of the beneficiary in bankruptcy.
The Court ruled that an inherited IRA does not fall under the Bankruptcy Code §522(b)(3)(C) exemption which states that a debtor may exempt amounts from bankruptcy that are both (1) “retirement funds,” and (2) exempt from income tax under one of several specified Internal Revenue Code provisions. Code Sec. 408 provides such a tax exemption for IRAs. The Supreme Court ruled that funds held in an inherited IRA are not “retirement funds” for purposes of the Bankruptcy Code.
According to the Court, the exemptions provided in the Bankruptcy Code create a balance between the rights of creditors and the needs of debtors. Allowing debtors to protect funds held in traditional and Roth IRAs aligns with this balance by helping to ensure that debtors will be able to meet their needs during retirement and get a “fresh start”.
The Court ruled beneficiaries of inherited IRA accounts are not entitled to a “free pass” since there is no limitation on the amount that inherited IRA beneficiaries can receive and the inherited IRA account itself was not tied to the beneficiary’s retirement.
Planning: Make the beneficiary of your IRA or retirement account a trust benefiting family members who have potential creditor problems to protect the IRA account from beneficiary bankruptcy.
In addition, a spouse who inherits an IRA account may receive creditor protection not available to other beneficiaries since a spousal beneficiary has the option of treating the IRA as his or her own, rather than being subject to the general rules for “inherited IRAs.” When the surviving beneficiary spouse chooses to be treated as the IRA owner, he/she may defer the start of lifetime IRA distributions to his or her required beginning date after retirement. This situation is factually distinct from that of the Clark case.
If you need help with your IRA contributions, don’t hesitate to contact a Henry+Horne professional adviser.