In a landmark decision handed down on June 12, 2014, the United States Supreme Court held that inherited IRAs are not protected from creditors in a bankruptcy claim. In Clark v. Rameker, the Supreme Court unanimously held that retirement funds inherited by a beneficiary after the original plan participant’s death are not considered “retirement funds” in accordance with the federal bankruptcy exemptions. Consequently, an inherited IRA may be considered an asset of a bankruptcy estate from which to satisfy creditors’ claims.
The opinion, written by Justice Sonia Sotomayor, will have lasting implications for those filing bankruptcy claims in the future. In this landmark case, Heidi Heffron-Clark had inherited an IRA from her mother, before filing for bankruptcy. The case raised the question of the legal distinction between inherited IRAs and those set up and funded on one’s own. Inherited IRAs have various features that set them apart and indicate that they are not retirement assets. Because inheritors cannot add funds to the account and can withdraw funds at any time without suffering a penalty, they differ substantially from retirement accounts, which are designed to protect savings for the long term so there is money available for retirement.
In Clark v. Rameker, Heffron-Clark’s mother named her daughter as sole beneficiary of her IRA account worth about $450,000 when she died. When Heffron-Clark filed for bankruptcy 9 years later, the account was worth approximately $300,000. She argued that because it was “retirement funds,” it should not be available to creditors. The bankruptcy court originally sided with the creditors, who objected to her argument. The bankruptcy court decision was appealed to the District Court of the Western District of Wisconsin where the decision was reversed. That decision was overturned by the 7th Circuit U.S. Court of Appeals before finding itself in the Supreme Court.
The decision also has an important impact on spouses, who are given an option not available to other inheritors. Once an IRA is inherited, a spouse is able to roll the assets into their own IRA and put off distributions until the age of 70 and a half. However, if the spouse chooses not to rollover the funds, the account is considered an inherited IRA and subject to creditors in a bankruptcy claim. Rolling over the funds into one’s own IRA has tax benefits as well, so this recent decision only amplifies the financial benefits of a rollover
In order to protect inherited retirement assets from creditors, a Standalone Retirement Trust may be a smart option. A Standalone Retirement Trust is set up as a third-party trust, funded with retirement assets upon the death of an account holder. Because the asset protection features of irrevocable third-party trust laws apply, a beneficiary (in most jurisdictions) will have protection from claims of creditors because they did not establish the trust, did not fund the trust with their own assets, and can’t make changes to the trust.
If you are concerned about how this new precedent will impact your estate plan, Fields and Dennis, LLP can help. It is important to be informed about these changes so that you can do your best to preserve your retirement accounts so that they will be protected for your beneficiary’s future. While this recent judgment puts some inherited IRAs at risk, there are steps you may be able to take to protect your loved ones from being impacted by this decision.