Dear Clients, Colleagues, and Friends,
Last week, there was an extremely important case decided by the U.S.Supreme Court in the case of Clark v. Rameker. In Clark, Heidi inherited a traditional IRA from her mother in 2001, when the IRA was worth approximately $450,000. Nine years later, Heidi and her husband filed for Chapter 7 bankruptcy and identified the inherited IRA, then worth approximately $300,000, as exempt from the bankruptcy estate under the retirement funds exemption of the bankruptcy code. The case worked its way up the appellate court system and was in conflict with another case that had a contrary holding. So the Supremes took the case and unanimously decided that funds held within inherited IRAs are not considered “retirement funds,” and thus not protected from creditors in bankruptcy proceedings. As a result, Heidi’s inherited IRA was available to satisfy her debts in the bankruptcy proceeding.
An inherited IRA is a traditional or Roth IRA that has been inherited after its owner’s death. If the beneficiary is the owner’s spouse (as often is the case), the spouse has a choice: he or she may “roll over” the IRA funds into his or her own IRA at any time, or he or she may keep the IRA as an inherited IRA. When a beneficiary, other than the owner’s spouse, inherits an inherited IRA, he or she may only hold the IRA as an inherited account. Therefore, it is imperative that the creator of the account designate the proper IRA beneficiary while alive to avoid the adverse holding of the Clark case.
If the beneficiary of an inherited IRA is a resident of a state that has a state bankruptcy exemption statute for inherited IRAs, such as Texas, Florida, Missouri, or Alaska, Clark will not apply, and the inherited IRA will be protected from bankruptcy. However, leaving to chance the then applicable exemption law at your death is imprudent and risky, as the exemption laws may not be the same at the death of the one who created the IRA.
For those who own a traditional or Roth IRA and wish to avoid the adverse impact of the Clark case, having the funds paid to a simple beneficiary “spendthrift trust” for the benefit of your intended beneficiaries and their current or future creditors will have no claim to the account’s assets.1 For those who have already received the proceeds from an inherited IRA, either from a traditional or Roth IRA, it would be prudent to withdraw the funds and place them into an asset protection trust while your “financial seas are calm” and if a financially ruinous legal claim is encountered, the funds will be protected.
If the inherited IRA is the result of a traditional IRA, or a Roth IRA that was in existence less than five years at the time of the owner’s passing, there may be adverse income tax consequences when the funds are withdrawn, so check with your tax advisor before withdrawing the assets. Even if you have to pay tax, the transfer to an asset protection trust will at least preserve the remainder.
Please contact our office if you feel that further planning with your IRA, Roth IRA, or inherited IRA is the right move for you, and we will happily assist you in achieving your goals.
Creditors refers to: civil judgment, bankruptcy, divorcing spouses, delinquent taxes, and regulatory fines.