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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Tax Savings Opportunities for 2013 Using IRAs

IRAs can provide extra tax savings in 2013, even though the end of the year has passed. There are several key tools that you can use now to lower your tax bill.

Extra contributions are one way to save on taxes. If you make a contribution by April 15, 2014, you can apply it to your 2013 taxes. You may also be able to avoid extra taxes on an early distribution through a properly structured extra contribution. Taxpayers with self-employment income may also be able to shelter income by setting up a SEP before their returns are due.

You may be able to use other tools if you expect to have lower income in 2014. If you made a Roth contribution in 2013, you may be able to convert it to a traditional contribution. You may also be able to back out of a traditional-to-Roth conversion made in 2013. Both of these techniques can result in significant tax savings for your 2013 return.

© 2014 Parsonage Vandenack Williams LLC

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Seventh Circuit Denies Bankruptcy Exemption for Inherited IRA

One of the many reasons that IRAs appeal to investors is the asset protection they provide. IRAs are typically included within the protections given to retirement plan funds.  Bankruptcy law provides exemptions for retirement funds. Creditors are prohibited from attaching retirement fund accounts.

In a recent case, the Seventh Circuit held that once an IRA becomes an inherited IRA, such IRA is not subject to the same protection.

This ruling by the Seventh Circuit creates a circuit split. The Eighth Circuit (of which Nebraska is part) and the Fifth Circuit have previously held that inherited IRAs are exempt in bankruptcy. IRA owners should review their estate plans and consider whether the addition of a conduit trust as a beneficiary is a desirable way of adding more protection to the arrangement.

© 2013 Parsonage Vandenack Williams LLC

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