The Supreme Court in a unanimous decision written by Justice Sotomayor made it clear that inherited IRA’s are not protected from creditors under the Federal Bankruptcy Code. In the opinion the Court found that Heidi Heffron-Clark, who inherited an IRA from her deceased mother in 2001, and then filed for bankruptcy 9 years later, could not shield her inherited IRA from her creditors.

The Court focused on the interpretation of the term “retirement funds.” The Court interpreted the meaning of “retirement funds” under Section 522(b)(3)(c) to mean sums of money set aside for the day an individual stops working. The Court went on to say: “…we look to the legal characteristics of the account in which the funds are held, asking whether, as an objective matter, the account is one set aside for the day when an individual stops working.”

The Court said that there were three legal characteristics of an inherited IRA that make it so an inherited IRA is not what was meant by a “retirement fund” under the US Bankruptcy Code.  The three characteristics are:

1)      The holder of an IRA may never invest additional money into the account

2)      Holders of an inherited IRA must withdraw money from the retirement account, no matter how many years from retirement they may be.

3)      The holder of an inherited IRA may withdraw the funds at any time without penalty

The Court went on to expound upon how these three characteristics of an inherited IRA make it so that an inherited IRA is substantially different from a traditional or Roth IRA, and because of these differences an inherited IRA was not meant to be an exempt asset under the Bankruptcy Code. The Court further went on to say that the purpose of the exemptions in the Code are to protect the debtor’s essential needs. The Court said, “Allowing debtors to protect funds held in traditional and Roth IRAs comports with this purpose by helping to ensure that debtors will be able to meet their basic needs during their retirement years. “

“The same cannot be said of an inherited IRA. For if an individual is allowed to exempt an inherited IRA from her bankruptcy estate, nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete.”

Due to this unanimous decision by the United States Supreme Court it is now more important than ever to make sure that your estate plan is set up properly to ensure the greatest amount of protection for your IRA. With qualified estate planning trusts your IRA can be protected for your loved ones, despite this most recent ruling. Have your estate plan reviewed by an experienced estate planning attorney that understands these very complicated issues and they will show you how they can protect what the government won’t.

Contributed by MH Phoenix, Arrowhead and Scottsdale Estate Planning Attorney and Partner, David T. Eastman.

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This blog should be used for informational purposes only.  It does not create an attorney-client relationship with any reader and should not be construed as legal advice.  If you need legal advice, please contact an attorney in your community who can assess the specifics of your situation.