On June 12, 2014, the United States Supreme Court ruled that an IRA inherited by an individual (other than a spouse) is subject to a debtor’s creditors in a bankruptcy proceeding. Clark v. Rameker, 573 U.S. 7th Circuit (2014). In order to allow a debtor a fresh start, the bankruptcy code allows the debtor to exempt, protect or retain certain assets from his creditors while obtaining a discharge of his debts.
A traditional IRA, a Roth IRA and a 401(k) are exempt assets under the bankruptcy code. Prior to this Court’s ruling there remained a question if an inherited IRA is afforded the same protection as other retirement funds. Justice Sonia Sotomayor, writing for the Supreme Court, stated that “[n]othing 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”. Therefore, the Court held that an inherited IRA is not exempt or protected, and is subject to the beneficiaries’ creditors.
Designating a child as the beneficiary of retirement funds may not be the right choice if you are looking to provide creditor protection for your children’s inheritance. Setting up a proper third party trust can afford asset protection for your children not available if you leave the funds outright to them. Please call if you have any questions regarding the Supreme Court’s recent decision or to discuss options in setting up a trust with asset protection features.
Greg Steed is an Attorney at RBMN and the Practice Chair for the Trusts and Estates Practice Group.