In a recent decision, Clark v. Rameker,1 the U.S. Supreme Court unanimously held that inherited IRAs are not exempt from the beneficiary’s creditors because inherited IRAs are not “retirement funds” within the meaning of 11 USC §522(b)(3)(C) of the federal Bankruptcy Code. As a result, the creditors of the beneficiary of an inherited IRA may attach to an inherited IRA.
An inherited IRA is a traditional or Roth IRA that has been inherited after its owner’s death. When anyone other than the owner’s spouse inherits the IRA, he or she may not roll over the funds; the only option (absent certain permissible trustee-to-trustee transfers or Roth conversions) is to hold the IRA as an inherited account.
According to the Court, inherited IRAs are not exempt within the definition of “retirement funds” because the non-spouse beneficiary/owner may withdraw funds at any time without penalty, the beneficiary/owner of an inherited IRA cannot make contributions, and the owner must immediately begin withdrawing funds, regardless of age.
The Court in Clark v. Rameker, did not clarify if its holding applies to inherited IRAs of a surviving spouse, although there is no reason why it should not, if the spouse decides to accept account as an inherited IRA as opposed to opting to “roll over” said inherited IRA into an IRA of his/her own.
How can you protect an Inherited IRA account from creditors post- Clark v. Rameker?
In light of the recent Clark v. Rameker decision, clients must thoughtfully reconsider any outright beneficiary designations for their retirement accounts if they want to ensure that the funds will remain protected for their beneficiaries after death and also retain the advantages of “stretching” the mandatory withdrawals over the beneficiary’s life expectancy. A recommended course of action for protecting an inherited IRA is to create a See-Through (Conduit Trust) or an Accumulation IRA Trust for the benefit of all of the intended IRA beneficiaries or certain IRA beneficiaries. If properly drafted, these types of trusts offer the following advantages:
- Protect the inherited IRA from each beneficiary’s creditors, as well as asset predators and lawsuits;
- Ensure that the inherited IRA remains in the family bloodlines and out of the hands of a beneficiary’s spouse, or soon-to-be ex-spouse;
- Allow for experienced investment management and oversight of the IRA assets by a professional trustee;
- Prevent the beneficiary from wasting away the inherited IRA or making penalty free lump sum withdrawals for spendthrift items (i.e. wasteful entertainment, jewelry, and exotic cars);
- Enable proper planning for a special needs beneficiary; and
- Permit minor beneficiaries, such as grandchildren, to be immediate beneficiaries of the inherited IRA without the need for a court-supervised guardianship.