In a landmark decision last summer, the U.S. Supreme Court ruled that an inherited IRA is no longer a protected asset. This means that when your IRA reaches your children, it is no longer protected from their creditors or from bankruptcy.
This may not be late-breaking news, but the June 2014 ruling seems to have largely flown under the radar. And because so many of our clients own IRAs – and the implications of this ruling are so far reaching – we felt it important to re-open the discussion.
It all began back in 2005 when President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Often referred to as the “New Bankruptcy Law,” the BAPCPA was created to make it more difficult to file for bankruptcy under Chapter 7. One consequence (an unintended one, according to SCOTUS) was the inclusion of inherited IRAs and inherited Roth IRAs within the meaning of “retirement funds” in the new law. Bankruptcy trustees routinely took issue with this interpretation and, finally, in 2013 the case that changed it all reached the Supreme Court.
In Clark v. Rameker, the plaintiff, Heidi Heffron-Clark, filed for Chapter 7 bankruptcy protection and listed her inherited IRA as an exempt asset (unavailable to creditors). The response was a unanimous thud of the figurative gavel. Penned by Justice Sonia Sotomayor, the Court described inherited IRAs as “freely consumable” by the beneficiary and, as such, they should not be treated as retirement funds under the bankruptcy exception.
In making its decision, SCOTUS distinguished between inherited IRAs and owned IRAs, those you set up and fund yourself. The Court noted several features that suggest inherited IRAs are not retirement assets, including that inherited IRAs do not permit contributions, have no early withdrawal, and have ongoing distribution requirements regardless of age and retirement. (To the last distinction, generally non-spousal IRA heirs must either withdraw the entire account balance within five years or take a minimum amount each year. So, if for instance a four-year-old inherits an IRA, he must begin taking the required minimum distribution the following year when he turns five. Thus follows: Is that really for retirement?)
It isn’t all bad news. The ruling does appear to be limited to IRAs inherited by someone other than the spouse. Further, there are options available for individuals who want to leave an IRA to a non-spouse heir.
By setting up a living trust, you can protect an IRA you want to leave to your children or to someone other than your spouse. In a day and age where the term “pension” has become virtually obsolete and where saving for retirement is something “I’ll do one day,” it is understandable to worry about your children and want to leave them a little something. A living trust will do just that for your children – and for your peace of mind – and it will also keep those assets away from their creditors. For more information, schedule an appointment with The Edwards Law Firm today.