The Employer's Legal Resource: The Supreme Court Rules "Inherited" IRA's Subject to Creditors in Bankruptcy
The Supreme Court recently ruled that "inherited" IRA's-those received by a Beneficiary (such as the child(ren) of the deceased owner)-are subject to the claims creditors of the Beneficiary if the Beneficiary is in Bankruptcy.
In Clark v. Remeker, Mr. and Mrs. Clark had a pizza restaurant in Wisconsin and had accumulated debts of $700,000. Their chief asset was an IRA Mrs. Clark had inherited from her late mother. The Bankruptcy Trustee believed the IRA should be available to satisfy debts, while the Clarks argued the money constituted "retirement funds," which are exempt under the Bankruptcy Code. The Court sided with the Trustee.
The Court found that the IRA did not qualify as "retirement funds" in the hands of the Clarks. In the original IRA, Mrs. Clark's mother could add funds to the IRA and there was a significant penalty (10%) for early withdrawal, generally before the mother attained the age of 59 1/2, to encourage keeping the funds in the IRA until she reached retirement age. On the other hand, 1) a Beneficiary can never add money to an "inherited" IRA, 2) the Beneficiary, upon receipt, must begin a series of minimum annual distributions, even if the Beneficiary is well under the age of 59 1/2 and 3) there is no 10% early withdrawal penalty. The Beneficiary can withdraw the entire amount and only be liable for the ordinary income tax. Therefore, the Supreme Court concluded the IRA funds lacked the characteristic of "retirement funds" when the account passed to the daughter and were thus not exempt from creditor claims.
A few notes:
This does not affect ERISA plans, like a 401(k), 403(b) or defined benefit plans. They receive creditor protection under ERISA law.
IRA's are still exempt during the lifetime of the original owner, while he/she is the owner.
A special provision in the law allows a widow(er) to do a "spousal roll over." A widow(er) takes a deceased spouse's IRA and make it his/her own, so that it is not an "inherited" IRA but now belongs to the widow(er) as his/her own. The same option does not apply to other beneficiaries.
Sometimes state exemption law can make certain assets exempt. A few states have specifically exempted "inherited" IRA's. As in Wisconsin, Oklahoma does not appear to have done so. Based on this case, the Oklahoma legislature may decide to do so, although there will likely be significant pressure from banks and other creditor interests not to exempt "inherited" IRA's in Bankruptcy.
If an IRA owner has intended beneficiaries who may have creditor problems, establishing a spendthrift Trust for the benefit of (FBO) the intended individual as the beneficiary of the IRA will likely defeat the creditors. Attention to the drafting as part of the estate planning process is advisable.
Widow(er)s have the option of "inheriting" an IRA or rolling it over as their own, as described above. In most cases, the "spousal roll over" is preferable, for many reasons, including asset protection.
By Harry V. Rouse, email@example.com