Inherited IRAs Lose Their Protection

A recent U.S. Supreme Court decision has had a negative and rippling effect on the estate and financial planning community.

In the case of Clark v. Rameker, decided in June of 2014, the Supreme Court held that an inherited IRA will not be given the same protective treatment as a regular IRA in the context of bankruptcy. Until recently, all IRAs were protected in bankruptcy under the "retirement exemption." In other words, if a person filed for bankruptcy, he always had the comfort level of knowing that any retirement assets, including those inherited from another person such as a parent, would be protected. The Supreme Court, however, has now differentiated between an IRA that is owned by an individual and one that is inherited from another individual.

With respect to IRAs, when the owner of the IRA dies, the IRA passes to the beneficiary designated by the original owner. When a surviving spouse is the beneficiary, he/she can actually roll over the IRA into either his/her own existing IRA or into a new account, and the surviving spouse then becomes the new owner of the IRA. Such an IRA would actually be protected if the new owner ever filed for bankruptcy. However, the only person who can ever roll over an IRA or create a new one is a surviving spouse. Any other beneficiary must treat the IRA as an "inherited IRA."

For example, if a single mother leaves her $500,000 IRA to her two children, at her death, the IRA is divided into two separate and distinct IRAs - each valued at $250,000. The mother's name will remain on each IRA, with the name of the child listed as the beneficiary. The IRA will no longer be titled in the mother's name, but rather "Mother's IRA for the benefit of Child." This type of IRA is referred to as an inherited IRA or beneficiary IRA.

The Supreme Court's decision is directed to this type of IRA, and its reasoning is essentially that funds held in an inherited IRA do not inherently have the same traits as a traditional IRA. The premise for protecting a traditional IRA is that the IRA is the individual's primary retirement savings vehicle, and is comprised of funds that were saved for the individual's retirement over a lengthy period of time. The Court's holding does not accord this same reasoning to an inherited IRA, because the beneficiary did not save these funds for his/her retirement. Rather, they are inherited monies derived from a third party. Therefore, according to the Supreme Court, an inherited IRA should not merit any special treatment in a bankruptcy proceeding.

This holding is disappointing news for individuals who are struggling financially and hoping that if they do ultimately file for bankruptcy, at least some of their assets would be protected. There are some steps that may be taken in order to protect an inherited IRA, but it is important to consult with a trust and estates attorney who is well versed in this area.

Ronald A. Fatoullah, Esq. is the principal of Ronald Fatoullah & Associates, a law firm that exclusively concentrates in elder law, estate planning, Medicaid planning, guardianships, estate administration, trusts, wills, and real estate. Yan Lian Kuang-Maoga, Esq. is an elder law attorney at the firm. The law firm can be reached at 718-261-1700, 516-466-4422, or toll free at 1-877-ELDER-LAW or 1-877-ESTATES. Mr. Fatoullah is also the co-founder of JR Wealth Advisors, LLC. The wealth management firm can be reached at 516-466-3300 or 800-353-3775.