Inherited IRAs Are Not Protected From Creditors

By Mary E. Vandenack.

On June 12, 2014, the Supreme Court ruled that inherited IRAs are not “retirement funds” within the meaning of the federal bankruptcy exemption for retirement funds. In making its decision, the Court distinguished inherited IRAs from IRAs established and held by the owner who originally deposited the funds.

Heidi Heffron-Clark (“D”) became the owner of an inherited IRA in 2001 when her mother died designating Heidi as sole beneficiary of an IRA account. D and her husband filed bankruptcy in 2010 claiming the inherited IRA as an exempt asset under 11 U.S.C. §522(b)(3)(C). The Bankruptcy Court disallowed the exemption. The District Court reversed. The Seventh Circuit reversed the District Court. The Supreme Court granted certiorari to resolve a conflict between the Seventh and Fifth Circuits.

The Court based its conclusion that an inherited IRA is not a retirement fund on three legal characteristics of inherited IRAs. First, the holder of an inherited IRA cannot invest additional funds into an inherited IRA. Second, holders of inherited IRAs are required to withdraw money from the accounts regardless of their age when they inherit the IRA. Third, the holder of an inherited IRA can withdraw the entire IRA, without penalty, at any time whereas original IRA owners are subject to penalties on withdrawals before the age of 59 1/2.

The Court rejected the argument that the bankruptcy definition of retirement funds could be construed as any funds that were set aside for retirement simply because such funds were set aside for retirement by the original owner. The Court noted that such a definition would have the result of treating funds that had been set aside for retirement at some point in time being treated forever as retirement funds regardless of the withdrawal of such funds and later form. By way of example, the Court suggested that such definition would mean that an original IRA owner could withdraw funds, give the funds to a friend who would put the funds in a checking account and then later claim exemption based on the concept that the funds had previously been put in a qualified retirement account.

© 2014 Parsonage Vandenack Williams LLC

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