Last week, The Supreme Court unanimously ruled that the funds contained in an IRA are not protected from creditors after bankruptcy.
You may need to reevaluate how your estate plan deals with your IRA. If your beneficiaries live in Florida, this may not be a concern because the Florida Legislature has an IRA exemption statute which includes inherited IRAs. As it is difficult to predict where your beneficiaries will live at the time of your death, you may not be able to count on the Florida statutes to protect your beneficiaries.
We have recommended to make an asset protection trust the beneficiary of your trust to protect from the retirement funds from the loss that could be associated with creditors of our client’s beneficiaries (typically their spouse or children). Many have not seen the need for this and as a result, there may be many families using traditional beneficiary designations which place their retirement funds at risk.
Attorney and U.S. Bankruptcy Trustee William Rameker won a landmark case in Clark v. Rameker last week that will fundamentally change bankruptcy law. The Supreme Court Justices held funds contained in an IRA, which were inherited by Heidi Heffron-Clark after her mother died, did not qualify as retirement funds.
The general rule in bankruptcy law is an IRA held by the original owner is considered a retirement fund and is exempt from creditors. Before this case, there was a gray area in the law upon how to treat a non-spousal inherited IRA. This ruling has cleared up the confusion. Now these funds are no longer protected by the retirement exemption.
The court reasoned inherited IRAs do not operate like ordinary IRA’s. Unlike a traditional IRA, a person who inherits an IRA can withdraw funds from it at any time. The owner of an inherited IRA must actually withdraw all the funds or else be required to take minimum distributions on an annual basis. Additionally, the owner of an inherited IRA can never make contributions to the IRA.
Clark inherited the IRA after her mother died in 2001. When she first received the IRA it was worth over $450,000. She took monthly installments from this IRA until 2010, when she and her husband filed for Chapter 7 bankruptcy.
Rameker argued Clark’s inherited IRA, now worth $300,000, was not exempt from creditors under 11 U.S.C. § 522(b)(3)(C) because the funds in an inherited IRA are not “retirement funds.” The Bankruptcy Court agreed with Rameker, but was overturned by the District Court, which felt the law protected any funds that were originally accumulated for retirement purposes.
The District Court was then overturned by the Seventh Circuit Court, who held the differences between an IRA and an inherited IRA were fundamentally different. The most important difference to the Court was that an inherited IRA “represent[s] an opportunity for current consumption, not a fund of retirement savings.”
The Supreme Court agreed and found there was three legal characteristics that lead the Court to conclude funds held in inherited IRAs are not set aside for the purpose of retirement. These reasons included the IRA holder’s inability to invest more money into the account, and the law that requires the holder to withdraw the funds no matter how far from retirement the holder may be.
The Supreme Court reasoned the IRA holder’s ability to withdraw 100 percent of the funds from the IRA at any time without penalty was too dissimilar from a traditional IRA. In a traditional IRA, the holder is penalized a 10 percent tax penalty if he or she withdraws any funds before the age of 59.
How this holding will affect bankruptcy law is unclear as there is now a risk that IRA money left to heirs will no longer be protected from creditors if the beneficiary is in financial trouble. However, in Florida these inherited IRA’s may still be protected from creditors by state law.
Bankruptcy law is constantly changing, and therefore it is important to consult an experienced estate-planning attorney to ensure your estate is secure for your heirs. For more information on IRAs and estate planning, contact Florida attorney David Goldman at (904) 685-1200.