Last month the Supreme Court made a very significant decision – they ruled unanimously that an inherited IRA is not a “retirement account.” This means that inherited IRAs are now NOT protected in the case of bankruptcy under federal law. The unanimous decision could have far reaching ramifications depending on your specific circumstances.
President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) in 2005. The law was created to make filing for bankruptcy less attractive, however, retirement account owners found something else; bankruptcy protection of “retirement funds.” The loose phrasing of “retirement funds” in the bankruptcy statute was open to interpretation and soon bankruptcy trustees began challenging the exempt status of inherited IRAs. For the past few years, various courts have heard the issue with inconsistent rulings. The case before the Supreme Court that resulted in this official decision was Clark v. Rameker.
Heidi Heffron-Clark declared bankruptcy in October 2010. She claimed the IRA, inherited from her mother, then worth $300,000, qualified as “retirement funds,” therefore, not required to use it to pay debts they owed creditors. Heffron-Clark, never contributed to the IRA; she had already drawn $150,000 in monthly payouts from the account since her mother’s death in 2001. She could also withdraw the entire amount of the IRA any time, without penalty. The bankruptcy court ruled against Heffron-Clark, declaring that an inherited IRA represented “an opportunity for current consumption, not a fund of retirement savings.”
The Supreme Court agreed unanimously and ruled that Heffron-Clark’s inherited IRA cannot qualify for bankruptcy protection because these funds were not considered “retirement funds.” As a result, they were required to pay their creditors with the remaining amount in the inherited IRA.
The Court found that there are clear differences from an inherited IRA and the type of IRA someone builds over the course of a working lifetime. Specifically, inherited IRA holders are not able to invest more money into the account and beneficiaries of IRAs can take total distributions of their inherited accounts at any time and use the funds for any purpose without penalty.
What does this mean to you? Well that depends…
Although the Supreme Court’s decision doesn’t explicitly state one way or another, its ruling seems to be limited to IRAs inherited by someone other than a spouse. While making any assumptions in this area can be dangerous, it appears that an IRA inherited from one’s spouse would be exempt .
For some, state law may provide protection. During the last three years seven states have adopted laws expressly exempting inherited IRAs under state bankruptcy statutes – no Nevada is not one of these states so Las Vegas residents are not in luck.
Another alternative still available for the owner of the IRA is to leave the IRA to a trust for the beneficiaries. A trust can be very complicated so it is strongly recommended that a trust arrangement should only be considered with the assistance of a qualified professional.
Brad Zucker, RFC® is the president of Safe Money Advisors, Inc., a Las Vegas-based independent financial advisory firm. He blogs on personal finance every Monday for the RJ. For more information visit www.SafeMoneyAdvisorsNV.com or connect with him via Facebook and LinkedIn.