The U. S. Supreme Court recently ruled in a decision called Clark v. Rameker that inherited individual retirement accounts (“IRAs”) are not protected by the “Retirement Funds” Exemption under the U. S. Bankruptcy Code.

Here is the information you should know about your own IRA accounts:

In general, when an individual debtor files for bankruptcy protection, the debtor’s property becomes part of the bankruptcy estate.  The bankruptcy trustee will use the assets of the debtor’s estate to try to satisfy the creditors’ claims.  However, the Bankruptcy Code allows debtors who file for bankruptcy to keep certain types of property separate from the estate, allowing the debtor to have enough assets to subsist post-bankruptcy.

One type of property that is protected from creditors is non-taxable retirement funds and accounts, such as traditional IRAs and Roth IRAs.  One type of IRA is an “inherited IRA”, which is one that has to have been inherited upon the original IRA owner’s death.  If an IRA owner’s spouse inherits the IRA, the spouse may transfer or “rollover” the money into his or her own account and the spouse can choose to keep the IRA or the spouse can choose the IRA as a separate account.  Non-spouses who inherit an IRA are not permitted to “rollover” the IRA and must either keep the IRA as a separate account or cash out the IRA and pay income tax on it at that time.

The Supreme Court ruled in Clark v. Rameker that inherited IRAs are not protected assets in federal bankruptcy court proceedings.  The court found that the purpose of allowing debtors to exempt the retirement accounts from bankruptcy was to help ensure that debtors would be able to meet their basic needs during retirement while at the same time preventing them from enjoying a large cash windfall during a bankruptcy.  An inherited account holder could use the money in the inherited account at any time without penalty and certainly well before retirement.  Thus, because of this possibility, the court found that inherited IRAs are not exclusively set aside for retirement and don’t fall under the exemption.

How does this ruling affect you and your IRA beneficiaries?  Spouses who choose to rollover inherited IRAs into their own IRAs are not affected by the decision.  These accounts will still qualify for exemption from the bankruptcy estate.  However, spouses who do not choose the rollover option or those who inherit IRAs who are not spouses cannot take advantage of this retirement account exemption for bankruptcy purposes.

If you recently inherited an IRA from your spouse, this is a very good reason to roll it over into your own account immediately.  Once the rollover happens, the money in the inherited IRA is treated the same way as the money from your own account and any withdrawals before the age of 59½ are subject to tax and penalties.  However, the money is now protected from creditors during bankruptcy.

For those who inherit IRAs who are not spouses, to help protect the inherited assets, the original account owner of the IRA could designate a trust as beneficiary instead of an individual.  If the original account holder has not done that and an individual has already inherited the IRA outright, those accounts are now, unfortunately, available for creditors in the event of bankruptcy

If you have questions about the Supreme Court ruling and how it may affect you, your beneficiaries and your IRAs, please contact:
Stacey Willits McConnell, Esquire.
Chair of Lamb McErlane’s Estate Planning and Trusts Department.
Wills, Estate Planning and Trust Attorney West Chester, PA
610.701.4431 | smcconnell@lambmcerlane.com

At Lamb McErlane Ms. McConnell concentrates her practice in estate planning, administration of trusts and estates, charitable giving, and sophisticated wealth preservation and transfer techniques. Stacey is a member of Board of Trustees of The Episcopal Academy, serves on the Board of Directors for The Chester County Community Foundation and is also a member of the Philadelphia Estate Planning Council. She is a graduate of Duke University, Stetson College of Law and the Graduate Tax Program at Boston University School of Law.

Attachment:
 are_your_retirement_accounts_protected_from_bankruptcy_10-2014_swm.pdf