Wednesday, July 23, 2014

Are Inherited IRAs Protected From Creditors?

The United States Supreme Court addressed this question in the context of bankruptcy laws on June 12, 2014 in its decision in Clark v. Rameker.  In that case, the question presented was whether funds contained in an inherited IRA qualify as “retirement funds” within the meaning of the federal bankruptcy exemption.

In short, the United States Supreme Court held that inherited IRAs do not constitute “retirement funds.”  In other words, unlike traditional or Roth IRAs that are exempt from a person’s bankruptcy estate and thereby not subject to creditor attack, inherited IRAs are not so protected.  Thus, creditors can claim funds held in an inherited IRA in bankruptcy situations.

In finding that inherited IRAs are not “retirement funds,” the United States Supreme Court based its conclusion on three legal characteristics of inherited IRAs not indicative of traditional or Roth IRAs.  First, the Court reasoned that “the holder of an inherited IRA can never invest additional money in the account.”  According to the Court, this runs contradictory to the purpose of retirement funds in that they are intended to provide tax incentives for regular contributions.

Second, the Court reasoned that inherited IRAs are not funds set aside for retirement given the fact that inherited IRA account holders are required to withdraw money from the inherited IRA account regardless of the account holder’s proximity to retirement.  This feature results in a diminution of the inherited IRA account’s value, which according to the Court is contrary to the purpose of retirement funds.

Third, the Court reasoned that inherited IRAs are different than traditional and Roth IRAs in the sense that holders of an inherited IRA can withdraw the account balance, up to the whole thereof, at any time.  To the contrary, traditional and Roth IRA account holders are subject to penalties for most withdrawals made prior to attaining the age of 59 ½.  Thus, traditional and Roth IRA account holders are encouraged to leave such account funds untouched prior to retirement age.  Such is not the case with inherited IRAs.  For the reasons above, the United States Supreme Court held that inherited IRAs are not “retirement funds” and therefore are subject to creditor claims in bankruptcy. 

Nevada, like many other states, has opted out of the federal bankruptcy exemptions and instead adopted its own exemptions, save for a couple of exceptions.  In Nevada, up to $500,000 in certain retirement accounts is exempt from execution.  However, Nevada law does not specifically exempt inherited IRAs.  Even if a particular state does protect inherited IRAs, there is no guarantee that each IRA beneficiary will never move from that state to a state that does not protect inherited IRAs.  Accordingly, it is now important to consider whether to designate a trust as the beneficiary of IRAs and qualified accounts for asset protection purposes.  If you have questions in this regard, please contact our offices.
 

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