Supreme Court Decision Makes Inherited IRAs Fair Game in Bankruptcy

A recent U.S. Supreme Court decision has changed the way inherited IRAs are viewed when it comes to bankruptcy, and calls for those who inherit these retirement account assets to find new ways to protect that inheritance.

In Clark v. Rameker, Heidi Heffron-Clark inherited an IRA from her mother. She received distributions from that inherited IRA for several years before filing Chapter 7 bankruptcy. Ms. Heffron-Clark relied on the Bankruptcy Code, which states that IRAs are exempt up to $1.245 million from bankruptcy, to claim that her inherited IRA qualified for the retirement account exemption.

In a unanimous ruling, the Supreme Court disagreed, distinguishing inherited IRAs from other IRAs established by an individual for his or her own retirement. Because the beneficiary of an inherited IRA cannot make contributions to that IRA, an inherited IRA does not provide any tax incentives, which is an important purpose of other IRAs. Since the beneficiary of an inherited IRA has different rules for taking distributions than other IRA owners, this also establishes inherited IRAs as different from other IRAs. These differences, the Court reasoned, are enough to disqualify an inherited IRA from qualifying for the federal bankruptcy exemption.

Even though some states offer protection for inherited IRAs in bankruptcy, a move to another state that does not offer this protection can endanger inherited IRA assets. IRA owners who wish to provide their heirs with valuable protection should consider naming a trust as beneficiary of IRA assets instead of heirs, who could instead be designated as beneficiaries of that trust.

The Court did not address spousal inherited IRA beneficiaries; however, since a spouse is allowed to roll over an inherited IRA into his or her own account, this may qualify a spousal inherited IRA for the bankruptcy exemption for retirement funds.

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