INHERITED IRA IS NOT SAFE FROM CREDITORS IN BANKRUPTCY

In June the Supreme Court held that an inherited individual retirement account (IRA) was not protected by federal bankruptcy law. Specifically, the Court considered whether an inherited IRA is a “retirement fund” within the meaning of the bankruptcy code and thus entitled to federal bankruptcy protection. The Court surprised everyone by ruling inherited IRAs are available for distribution to creditors just like any other debtor account. Click here to view the opinion.

To understand the significance of this decision, first a bit of background is in order. The Bankruptcy Code generally protects a debtor’s “retirement funds” from a debtor’s bankruptcy estate thereby keeping it out of reach from creditors. However, trustees and creditors began to attack inherited IRAs (as opposed to an IRA that you actually contributed) and ask if an inherited IRA where you did not contribute any of your money was fundamentally different from an IRA that you personally funded.

The Court relied primarily on three points to reach the conclusion that inherited IRAs were not retirement funds and thus not entitled to protection under the bankruptcy code. First, you cannot contribute money to an inherited IRA. Second, there are withdrawal requirements separate and apart from your retirement age and third, you can withdraw the balance at any time and for any purpose without a withdrawal penalty.

This ruling affects more than just the bankruptcy arena. For example, non-spousal beneficiaries under an IRA are at risk at having their IRA inheritance attacked by existing or future creditors. Perhaps the better plan now in light of this recent decision is to designate a spendthrift trust for the benefit of the beneficiary? The corpus of the trust would be protected if drafted properly and distributions to the beneficiary could be made over the life of the trust. While there are other options available, the point is that there are new considerations that must be taken into account in light of this recent decision by our Supreme Court that impacts not only estate planning going forward but also past estate planning decisions.
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Please feel free to contact the lawyers at Danziger Shapiro to discuss this and other business concerns you may have.

This entry is presented for informational purposes only and is not intended to constitute legal advice.