Inherited IRAs As Retirement Accounts

On June 12, 2014, the Supreme Court ruled 9-0 that funds received via an inherited IRA from a non-spouse may not be protected in bankruptcy, virtually solidifying that inherited IRAs are not treated the same or viewed as retirement accounts.

In 2001, Heidi Heffron-Clark inherited an IRA worth a little more than $450,000 from her deceased mother. Nine years later, Clark filed a Chapter 7 bankruptcy petition with her husband. The Court ruled the inherited IRA, worth $293,000 at the time of the 2010 filing, could be taken by creditors to cover her debts.

Deborah Jacobs wrote in Forbes Magazine about the uniqueness of inherited IRAs: “Unlike IRA owners, inheritors can’t put additional funds into the account, and they can take out money at any time without penalty. In fact, generally, non-spousal IRA heirs must either withdraw the entire account balance within five years of the original owner’s death, or take out a minimum amount each year, starting by Dec. 31 of the year after the IRA owner died.”

Money in IRA accounts is not typically covered by wills and instead requires beneficiary designation. Ruth Heffron made her daughter the sole beneficiary of the IRA account in 2000, and Clark had drawn the account down to less than $300,000 by the time she filed for bankruptcy protection in October 2010. While Clark argued with creditors that the money was “retirement funds” and should be protected, the Supreme Court overruled that belief.

Jacobs noted that this decision will have far-reaching implications and ramifications, especially for spouses. A spouse who inherits an IRA has the option to roll the assets into his or her own IRA and postpones distributions from a traditional IRA until he or she turns 70½. But like other IRA owners, he or she may have to pay a 10 percent early-withdraw penalty if money is taken before age 59½. Without the rollover, the account is considered an inherited IRA, and therefore not protected in bankruptcy, giving spouses another reason to consider rolling over the funds.

Jacobs also wrote that this decision does not affect bankruptcy protection for retirement accounts of your own, which were expanded or strengthened by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. But it does interpret a key ambiguity in the law. For more information on IRAs – inherited or owned – and bankruptcy protection, contact your financial planner.