Protecting a qualified Individual Retirement Account (“IRA”) is important to the people who rely on their IRA accounts when they retire and from time to time, when they borrow from them in certain situations. Creditors often try to persuade debtors to cash in or borrow from their IRA to pay debts, and some people succumb to pressure when they fear losing their house, car and personal property in a lawsuit if a creditor makes good on their threats.
What many people do not know is that their IRA is protected from bankruptcy proceedings. The trustee will not make you empty your qualified IRA when collecting assets to pay off creditors. Some people call IRA assets “bulletproof” money because of its nature in being beyond the reach of creditors.
What happens, however, when you inherit an IRA account? The U.S. Supreme Court recently decided that the funds in an inherited IRA are not protected in bankruptcy.
The case of Clark v. Rameker, involves a bankruptcy petitioner, Ms. Heidi Heffron-Clark, who inherited her mother’s IRA in 2001. Nine years later when she filed her petition for bankruptcy, Clark sought to exclude approximately $300,000 held in the inherited IRA, from the bankruptcy estate, using the “retirement funds” exemption. “The Bankruptcy Court concluded that an inherited IRA does not share the same characteristics as a traditional IRA and disallowed the exemption. The District Court reversed, explaining that the exemption covers any account in which the funds were originally accumulated for retirement purposes. The Seventh Circuit disagreed and reversed the District Court.” The Supreme Court, on review, held that, “Funds held in inherited IRAs are not “retirement funds…[i]”
The Court’s analysis over whether inherited funds were meant to be treated like originally accumulated funds, by the individual owner, were the same under the legal meaning of “retirement funds” in the bankruptcy code of laws. IRAs are certainly unique and some of these features were noted in a recent Forbes article about this case, “Unlike IRA owners, inheritors can’t put additional funds into the account, and they can take money out at any time without penalty. In fact, generally, non-spousal IRA heirs must either withdraw the entire amount each year, starting by Dec. 31 of the year after the IRA owner died.[ii]”
An IRA rollover, to a spouse, is one additional notable impact of this case.
Reports on this case also note the Court’s decision does affect an individual who inherits an IRA from their spouse. They are allowed to receive their spouse’s IRA funds and have the option of rolling those monies into their own IRA – this option is only available for spouses. As mentioned in Forbes, “She can roll the assets into her own IRA and postpone distributions from a traditional IRA until she turns 70 ½. The catch is, like other IRA owners she may have to pay a 10% early-withdrawal penalty if she takes money before age 59 ½ from her own IRA.[iii]”
Here is a link to another relevant article: Five Rules For Inherited IRAs.
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[i] U.S. Supreme Court Opinion: CLARK et ux. v. RAMEKER, TRUSTEE, et al., No. 13-299, Decided Jun. 12, 2014.
[ii] Forbes: Supreme Court Finds Inherited IRAs Not Protected in Bankruptcy. By Deborah L. Jacobs, Jun. 12, 2014.
[iii] See Forbes article (FNii).