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Supreme Court: No Bankruptcy Protection for Inherited IRAs

Inherited IRAs are not protected from creditors under the bankruptcy code. In a unanimous ruling, the U.S. Supreme Court upheld a lower court ruling. The decision applies specifically to inherited IRAs and not other kinds of individual retirement accounts.

The case involved Heidi Heffron-Clark and her husband, Brandon Clark, who had sought to protect inherited assets from their creditors. As we discussed in the July 2013 AAII Journal (“Inherited Non-Spousal IRAs Bankruptcy Exemption Questioned”), Heidi was the designated beneficiary of her mother’s traditional IRA. Heidi inherited the account in 2001. In 2010, she and her husband filed for Chapter 7 bankruptcy.

Writing for the court, Justice Sonia Sotomayor acknowledged the exemption in the bankruptcy code for retirement accounts. She described the reference to ‘retirement funds’ in the code as referring to “sums of money set aside for the day an individual stops working.” Based on this definition, whether funds in an account qualify for protection from creditors depends on the legal characteristics of the account they are held in.

The funds held within inherited IRAs are not set aside for retirement because of three legal characteristics, wrote Sotomayor. First, additional funds can never be contributed to an inherited IRA. In contrast, she noted, “The entire purpose of traditional and Roth IRAs is to provide tax incentives for accountholders to contribute regularly and over time to their retirement savings.” Second, beneficiaries of inherited IRAs are required to either withdraw the entire balance within five years after the owner’s death or take minimum withdrawals every year. Sotomayor described these requirements as being “hardly a feature one would expect of an account set aside for retirement.” Finally, the owner of an inherited IRA can make withdrawals at any time, whereas traditional and Roth IRA owners incur a penalty for withdrawing before the age of 59½. The justice called the age-based limitation a “rule that encourages individuals to leave such funds untouched until retirement age.”

Sotomayor further noted that the bankruptcy protections afforded to traditional and Roth IRAs are intended to protect the debtor’s needs in retirement. Applying those protections to inherited IRAs would be the equivalent of giving a debtor a “free pass” since the funds could be used to purchase “a vacation home or sports car immediately after her bankruptcy proceedings are complete.”

Source: “Clark et ux v. Rameker, Trustee, et al,” U.S. Supreme Court, No. 13-299, June 12, 2014.


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