In June 2014, the United States Supreme Court unanimously found that IRAs that are inherited, are not protected from creditors in a bankruptcy proceeding because they are not considered “retirement funds” as interpreted by the Bankruptcy Code.
In the case, CLARK V. RAMEKER, an individual inherited an IRA from her mother and later filed for bankruptcy. At the time she filed for bankruptcy, the IRA had roughly $300,000.00 remaining. Typically, when filing for bankruptcy, certain assets are considered exempt, including retirement funds. However, until this case was decided it was unclear whether an IRA which is inherited receives the same protection as an IRA as an IRA that is still held by the original contributor. To the detriment of the IRA beneficiary, the United States Supreme Court found that inherited IRAs do not have the same protections.
The determining factor was based on legal distinctions between an IRA that one has created on their own and one that is inherited from someone else. IRAs that are funded during lifetime are meant to be used to support the holder during retirement and therefore protection from bankruptcy is justified. However, once an IRA is inherited (both traditional and Roth), the funds are no longer considered retirement assets because inheritors cannot contribute additional funds to the account and can withdraw money from it at any time without penalty.
Inherited IRA vs Spousal Rollover
It is important to distinguish an Inherited IRA from a spousal rollover. When an owner of an IRA dies and names their spouse as a beneficiary, that spouse can rollover the funds into a new IRA and it can be treated as if it was their own. As with the original IRA owner, the spouse must take distributions at age 72.
The SECURE Act eliminated the lifetime stretch for most beneficiaries of IRAs. The only eligible designated beneficiaries who can still take required minimum distribution over their lifetime (which they must do each year based on their life expectancy, starting by December 31 of the year after the IRA holder died, regardless of their age) are the spouse, those with a disability or chronic illness, those not more than 10 years younger than the decedent, and minor children of the decedent. Everyone else must withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death, the 10 year rule.
IRA Trusts and Protection from Bankruptcy
One way to protect an inheritor from their creditors is to create a trust which can accept retirement assets either in a trust created under the IRA holder’s Will or a free-standing trust. In order to “accept” retirement accounts, the trust must qualify as one of two types of a “see-through trust.” A “conduit trust” is one in which the minimum required distributions of the IRA flow through to the beneficiary. An “accumulation trust” allows any distributions to accumulate within the trust and can be used for the beneficiary at the discretion of the Trustee. With the SECURE Act eliminating the required minimum distribution for all but a limited amount of beneficiaries, most trusts will be accumulation trusts. However, such trusts will have to distribute to beneficiaries within 10 years or the trust income is taxed at the highest marginal tax rate. Trusts for “eligible designated beneficiaries” must be conduit trusts.
Once an IRA trust is created either under a Will or a standalone trust document, the designated beneficiaries must be changed with the institution holding the IRA. This should only be done with the assistance of a professional since the IRS has specific titling requirements when naming a trust as a beneficiary.
IRA Planning for the Future of Your Estate
It is well established that designating a trust as the beneficiary of an IRA can be a useful tool for beneficiaries such as minors or disabled individuals who cannot manage their own funds. The decision in CLARK V. RAMEKER solidified the importance of IRA planning for beneficiaries who may encounter creditor problems. For assistance in planning your estate to protect IRA assets, you should consult with an experienced trusts attorney.