by Thomas D. Begley, Jr., CELA
The United States Supreme Court in a 9-0 unanimous ruling held that an inherited IRA is not protected in bankruptcy under federal law. Heidi Heffron-Clark inherited an IRA from her mother in 2001 and filed for bankruptcy nine years later. The court held that the IRA was not shielded from her creditors, because the funds were not earmarked exclusively for retirement. The Supreme Court indicated that creditor protection does not apply to inherited IRAs for a number of reasons:
- Beneficiaries cannot add money to an inherited IRA like IRA owners can to their accounts;
- Beneficiaries of inherited IRAs must generally begin to make Required Minimum Distributions (RMDs) in the year after they inherit the accounts regardless of how far away they are from retirement;
- Beneficiaries can take total distributions of their inherited accounts at any time and use the funds for any purpose without a penalty. IRA owners must generally wait until age 59-1/2 before they can take penalty-free distributions.
The court held that inherited IRAs do not contain funds dedicated exclusively for use by individuals during retirement. As a result, the favorable bankruptcy protection afforded to retirement funds under the Federal Bankruptcy Code does not apply.
The court did not rule on whether a Spousal Rollover IRA is protected from creditors. Like other IRA owners, if the money is rolled into their own IRA, they may have to pay a 10% early-withdrawal penalty if money is taken before age 59-1/2. If the money is not rolled over into the Spousal Rollover account, then it would appear that the assets will not be protected in bankruptcy.
A way to safeguard IRA and other retirement account assets from creditors is to name a trust as beneficiary of the retirement account.
Trust as Beneficiary
- The best practice is to name a standalone retirement trust as beneficiary for IRAs and other tax-deferred retirement accounts. Naming a trust as beneficiary provides more control. A trust can be drafted to protect the assets from a beneficiary’s creditors.
- If retirement account monies are left directly to heirs, the funds may be squandered by the heirs defeating any benefit of the long-term tax deferral. The trust provides protection from premature withdrawal.
- If the heir is divorced, the retirement account funds may be subject to claims of the non-heir spouse, or if the IRA is in a trust, the non-heir spouse will not be able to attach them.
- Benefit of Beneficiary. If a parent names a child as beneficiary of the parent’s retirement account and subsequently the child dies, that child may name the child’s spouse as beneficiary and the child’s spouse may remarry naming the new spouse as beneficiary. The retirement account would no longer remain in the bloodline. The trust can be designed so that on the death of the child the account passes to other family members and is kept in the bloodline.
- Special Needs. If the beneficiary has special needs, the trust can be drafted to protect the beneficiary’s entitlement to government programs such as SSI, Medicaid or any other means-tested public benefits.
- Finally, if the funds are placed in a trust no guardianship proceeding is needed upon the beneficiary’s incapacity.
 Clark v. Rameker, 134 S. Ct. 2242 (2016).