Asset Protection Planning

August 13, 2014

Inherited IRAs are available to bankruptcy creditors.

By Frederick J. Gawronski

The United States Supreme Court unanimously ruled on June 12, 2014 in Clark v Rameker, that non-spousal inherited IRAs are not exempt from a debtor’s estate in bankruptcy.

This case involved an IRA that petitioner Heidi-Heffron Clark inherited from her mother in 2001. Heidi received distributions from the IRA for 9 years. In 2010, Heidi and her husband filed for Chapter 7 bankruptcy. In the Wisconsin couple’s schedules, they listed Heidi’s inherited IRA as retirement funds and hence exempt from the reaches of creditors.

The Bankruptcy Trustee, Rameker and the couple’s creditors disagreed, claiming the funds from the inherited IRA were merely Heidi’s inheritance, thus becoming an asset of the bankruptcy estate and available to creditors.
Writing for the Court, Justice Sotomayor noted that the phrase “retirement funds” is not defined in the Bankruptcy Code, so a normal meaning must be applied to the term. The Court concluded that its ordinary meaning as ‘sums of money set aside for the day an individual stops working”. In the Court’s view, there are three characteristics differentiating inherited IRAs from retirement funds:

  1. The holder of an inherited IRA is prohibited from contributing additional money to the account;
  2. The holder of an inherited IRA is required to take mandatory withdrawals from the account without regard to the holder’s retirement; and
  3. The holder of an inherited IRA may withdraw the entire balance of the account at any time, use it for any purpose, all without penalty.

As indicated by the Court, the result is consistent with general debtor-creditor law and the Bankruptcy Code. Exempting a traditional, non-inherited IRA is to provide for the retirement needs of the debtors, even to the detriment of creditors. A non-spousal inherited IRA serves no such purpose.

PLANNING NOTE: The ruling only applies to the federal bankruptcy exemptions. There are several states which do protect these types of IRAs, including Florida and Texas. New York does not have such an exemption. And the exemption applies to the debtor’s location, not the person leaving the inheritance. Accordingly, those individuals with IRAs who want the balance of the money to be protected from their heirs’ creditors should designate a spendthrift trust as the beneficiary of the balance, not the heirs directly.