If you inherit the proceeds of another person’s IRA (“Individual Retirement Account”), your creditors may be able to reach and attach those proceeds, based upon a recent United States Superior Court Decision, Clark v. Rameker, 573 U.S. ____ (2014). What the Court held was that if a person has their own IRA then under the current Federal law, creditors can not touch the proceeds inside the account. However, retirement funds inherited by a beneficiary from the original plan participant are not considered to be “retirement funds”. To put it in plain English, at the time of your death, if you simply designate a beneficiary of the remaining funds in the account, that transfer would be considered a gift, and not an actual retirement account with the same asset protection against creditors as a retirement account. This decision was predicated on the fact that unlike the original person who invested into the IRA, an intended beneficiary must withdraw the funds within 5 years, no matter how far they are from retirement or take the minimum required distributions based upon their life expectancy. The beneficiary can also at any point withdraw all of the funds without any tax penalty. The Court discussed the fact that allowing debtors to protect funds held in traditional and Roth IRAs ensures that debtors will be able to meet their basic needs during their retirement years, when they stop working. At the same time, there are legal limitations to ensure a Debtor does not take those funds while they are still working without a significant deterrent. However, an inherited IRA is not meant for the same purpose. There is nothing in the law that prevents a beneficiary of an inherited IRA from immediate taking all the money to buy a luxury item, such as a sports car or a vacation home. To this end, the Court could justify treating the inherited IRA differently than a retirement account.
This recent decision, opens up the door to several problems. First, in the event a beneficiary recipient of the IRA were to file for personal bankruptcy, the Trustee would be able to take any funds that exceeded the exemptions allowed pursuant to 11 U.S.C. §522(b)(3), which as of right now is set at a maximum of $11,975. The Trustee could take those funds and could pay the beneficiary’s creditors and even take court costs, and trustee fees out. In addition, if the beneficiary were to be sued by someone for breach of contract for not paying a bill, or even was involved in a car accident, where their auto insurance did not satisfy the full amount of damages, a creditor could seek to attach all of the proceeds of the IRA.
Although this news is not very good for protection your assets for the benefit of your children, spouse or other intended beneficiaries, there is some good news that came out of the case. The court took special care to note, that proper estate planning, can still protect your intended beneficiary’s interest in the IRA funds through an Separate IRA Preservation Trust which is an irrevocable trust, where they are not the Trustee, but only a named beneficiary and where they will not have control over the asset as it were their own, but subject to the oversight of a fiduciary Trustee providing funds for the beneficiary’s benefit.
As with any blog or article on legal theories and strategy, this article is intended for informational purposes only and each person’s situation is unique. As such, before taking any action such as retitling an IRA you should consult with an attorney handling estate planning and an understanding of bankruptcy law such as the lawyers at Goldstein and Clegg, LLC.