Last week, the Supreme Court unanimously ruled that inherited IRAs are not protected in bankruptcy under federal law.

The Court’s decision resolved the bankruptcy question about inherited IRAs in the federal courts, but it does not resolve all questions because state laws also control the bankruptcy protection. Each state’s law is different, here is a site if you want common state bankruptcy exemptions, but this is an overview and isn’t intended to take the place of legal counsel.

This decision could have far reaching ramifications and depending on the circumstances, IRA owners may need to think before deciding which heirs should be IRA beneficiaries upon their death.

The Court’s decision presumably will not affect spousal beneficiaries, though the decision doesn’t state. There are several special rules for spousal beneficiaries in the tax code, including the ability for a surviving spouse to rollover the IRA into their own.

Here’s a summary behind the decision:

  • The enactment of BAPCPA (bankruptcy consumer protection act – 2005) was designed to make filing for bankruptcy less appealing. For IRA and Roth IRA owners there was bankruptcy protection to “retirement plans” allowing these accounts an exemption of $1 million adjusted for inflation (currently $1,245,475). Employer sponsored plans have an unlimited exemption.
  • The use of “retirement funds” in the law has caused bankruptcy trustees to challenge the exemption under federal bankruptcy rules in the case of Inherited IRAs and Inherited Roth IRAs.
  • After well fought battles that started in 2010, the case of Clark v Rameker, Trustee was appealed to the Supreme Court. The Supremes’ primary issue was whether or not an inherited IRA is a retirement plan.

 The decision was that an Inherited IRA (Roth IRA) is NOT a retirement plan based largely on the following items:

  1.  Beneficiaries cannot add money to the inherited IRA the way and IRA owner can;
  2. Beneficiaries of Inherited IRAs must begin receiving RMDs (required minimum distributions) no matter how far away their retirement will be;
  3. Beneficiaries can take total distributions from the inherited IRAs at any time and for any purpose without penalty (IRA owners must generally wait until attainment of age 59 ½ before there is a penalty free distribution)

 

Please contact your JMF accountant or retirement specialist for more information.