What You Need To Know About Inheriting an IRA

Inheriting an IRA can be a great financial silver lining to the otherwise very sad passing of a relative, but you should be aware that a recent unanimous Supreme Court decision puts inherited IRAs very much in jeopardy in bankruptcy proceedings.

ERISA plans are protected from bankruptcy in that creditors cannot attach them, and employers and plan administrators cannot release funds from them to creditors. This means that ERISA plans are excluded assets in bankruptcy. Non-ERISA plans, like IRAs, are exempted, meaning that they are included in the bankruptcy estate, but are not available to satisfy creditors.

Many states have no statutory bankruptcy exemption for inherited IRAs (although Missouri does). In the Clark v. Rameker decision recently handed down by the Supreme Court, the court agreed unanimously with the lower circuit court in ruling that inherited IRAs were not “retirement funds” under the bankruptcy code and therefore were available to creditors in bankruptcy.

In reaching its decision, the Court noted several factors that led them to decide that inherited IRAs should be available to bankruptcy creditors. Firstly, inherited IRAs prohibit any additional contributions, while other IRAs (those established for retirement) provide incentives for account holders to regularly contribute. Second, owners of inherited IRAs can liquidate the entire account at any time, for any purpose, without penalty. This is in contrast to a standard IRA, which imposes penalties for withdrawals before age 59 ½. Finally, inherited IRA holders must withdraw all funds within five years from receipt of the account, or under certain conditions may spread the payments out over a longer period as required minimum distributions, but must begin taking the distributions now regardless of how far they are from retirement. This is directly opposite a traditional IRA, which as previously stated, can only be withdrawn from without penalty after age 59 ½.

The Supreme Court notes that there is nothing in the rules regarding inherited IRAs that prohibit an owner from using the entire balance for whatever purpose they desire. If the debtor in bankruptcy would be allowed to use the funds outside of bankruptcy, it would undermine the public policy considerations that make up the bedrock of our bankruptcy code.

These issues can be very complicated. Please do not hesitate to contact the Hood Law Group if you would like to discuss your individual situation.

*This post was originally published on December 3, 2014