No Bankruptcy Protection for Inherited IRAs

Back in January I wrote a post about a case going before the Supreme Court about whether an inherited IRA would be protected in bankruptcy.  Well, it’s June and that means the Court is churning out its end-of-term decisions, including the inherited IRA case In Re Clark.  In short, inherited IRAs do not receive protection in bankruptcy proceedings.

Generally, bankruptcy law exempts (or protects) a debtor’s IRA and other ERISA qualified retirement accounts.  The reason is “retirement funds” are exempt.  The Court concluded the definition of “retirement funds” is properly understood “to be sums of money set aside for the day an individual stops working.”

The Appellate court in In re Clark, 714 Fc3d 559 (7th Cir. 2013), held that the bankruptcy debtor’s inherited IRA was not an exempt asset on the basis that it did not qualify as “retirement funds” under 11 USC § 522(b)(3)(C).  The court went on to indicate that an IRA constitutes “retirement funds” only if it is held for the owner’s retirement.  The Supreme Court, in a unanimous 9-0 opinion written by Justice Sotomayor agreed, holding inherited IRAs are not “retirement funds” and therefore not exempt under the Bankruptcy Code.

The Court found three legal characteristics of inherited IRAs provide objective evidence that they do not contain such [retirement] funds.

First, the holder of an inherited IRA may never invest additional money in the account. 26 U. S. C. § 219(d)(4).  Second, holders of inherited IRAs are required to withdraw money from the accounts, no matter how far they are from retirement. §§ 408(a)(6), 401(a)(9)(B).  Finally, the holder of an inherited IRA may withdraw the entire balance of the account at any time — and use it for any purpose — without penalty. Pp. 4-6.

The debtors in Clark, who were not retired, received monthly payment from the account and used the funds for regular expenses.  They were using the funds today and not for the day when they are no longer working.

So if you have a concern about a child inheriting your IRA and having it be available to creditors of that child, you may want to consider running the funds through a Conduit or other type of trust.

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