Court Rules Beneficiary IRA’s Not Protected In Bankruptcy

A very recent decision from the United States Supreme Court will change a common understanding regarding individual retirement accounts (IRA’s) in bankruptcy.  While your own IRA that was obtained through your own savings from employment will not be affected, an IRA inherited by your children will be. If you have inquiries about bankruptcy, you should meet with a bankruptcy lawyer to have them clarified and determine your best course of action. An experienced bankruptcy attorney from a highly reputed chapter 13 bankruptcy law firm will be able to guide you with your bankruptcy filing and will set proper expectations.

Here is what happened followed by what you need to know.

In 2001, Ruth Heffron died leaving her individual retirement account of about $450,000 to her daughter, Heidi Heffron-Clark.  Mrs. Heffron-Clark and her husband nearly ten years later declared bankruptcy.  When creditors claimed against the inherited IRA, the Clarks responded that the IRA which was then worth about $300,000 was protected in bankruptcy because it qualified under the law as “retirement funds.”  Clark v. Rameker.  One he decided to hire attorneys helping with bankruptcy in Hyannis, he learnt that the relevant section of the bankruptcy code protects “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under Section 401, 403, 408A, 414, 457 or 501(a) of the Internal Revenue Code.”  The funds were in an account exempt from taxation under Internal Revenue Code Section 408 – an IRA. Here you can get help with your financial operations as there are experts that can help you make the right financial decisions.

The question that was before the United States Supreme Court is whether an inherited IRA qualifies as “retirement funds.”  Their unanimous answer on June 12, 2014 was that it does not. The ones in a financial problem can find lawyers for ch 13 bankruptcy from Loveland area to help them out.

Inherited IRA’s have become an important part of estate planning.  Considering that, for most middle class Americans, their greatest equity is held either in their homes or in their retirement accounts or both, any decision that affects protection of their heirs receiving and keeping their retirement accounts is significant.   Here is why the Supreme Court decided that the bankruptcy protection that workers receive for their own individual retirement account does not extend to that account when inherited by their heirs. Understanding the creditor’s rights during a repossesion with the help of a lawyer might make things easier for everyone.

First, the Court interpreted the term “retirement funds” to mean money “set aside for the day an individual stops working.”  Inherited IRA’s are not funded with earnings of the heir and the heir, in fact, may not add to the inherited IRA account.

Another defining characteristic of the inherited IRA is that the beneficiary must begin taking minimum required distributions even long before retirement.  An heir can withdraw all of the money in the account without paying a penalty although, of course, taxes are paid.  The IRA of the worker who established it in the first instance is, unless some exception applies, subject to penalties for withdrawal before age 59 ½.

As to the Bankruptcy Code, the Court noted that shielding traditional and Roth IRA’s from creditors “helps to ensure that debtors will be able to meet their basic needs during their retirement years.”  The person who inherits an IRA would have access to the funds immediately after the bankruptcy proceedings are complete.

Although the decision, by Supreme Court standards, is brief, a mere 11 pages, it leaves a number of issues undecided.  For instance, what happens to the spouse who inherits?  The inheriting spouse could either roll the IRA received from his or her deceased spouse into his or her own IRA account and postpone distributions from the account until he or she reaches the required age or could take the account as an inherited account from her or his spouse.  If it is taken as an inherited account, then it would seem that the account would not be protected in bankruptcy.  This is an important consideration.

Another question is whether an inherited IRA could be protected by making the inheritance through a trust.  This is an extremely tricky proposition that should never be attempted except with an attorney who is fully conversant in “see through” trusts.  The reason is that, generally an IRA needs what is referred to as a “designated beneficiary,” which is usually considered to be a person or persons.  Otherwise there can be serious tax consequences.  An estate, for instance, is rarely if ever a good choice for beneficiary of an inherited IRA.

It is likely that the Clark case will be examined and re-examined by estate planning and bankruptcy lawyers to arrive at strategies for inherited IRA’s going forward.

For now, the important thing to know is that assumed protection of inherited IRA’s in bankruptcy no longer applies.

About the Author Janet Colliton

Esquire, Colliton Law Associates, P.C. Janet Colliton has practiced law for over 38 years, 37 of them in Chester County, Pennsylvania, a suburb of Philadelphia. Her practice, Colliton Law Associates, PC, is limited to elder law, Medicaid, including advice, applications and appeals, and other benefits planning including Veterans benefits, life care and special needs planning, guardianships, retirement, and estate planning and administration.

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