Last month, the U.S. Supreme Court unanimously ruled that inherited individual retirement accounts (IRA) are subject to creditor claims in bankruptcy. In layman’s terms … if you pass away and have an IRA and your IRA beneficiary has to declare bankruptcy, your IRA money could wind up in the hands of the creditors your beneficiary owes money to.
Because of this court ruling, if you have an IRA, you should consult with your advisors (attorney and financial advisor) who are experienced in asset protection, estate planning and income tax considerations for IRAs. This is especially important if you have a material balance in an IRA and an intended beneficiary has known or potential creditor issues.
Digging Into The Details
An inherited IRA is where an individual is named as a beneficiary on an IRA application document and the individual becomes the holder of an account after the original owner of the account passes away.
In Clark v. Rameker, the Supreme Court reviewed three important distinctions between an inherited IRA when compared to other traditional retirement assets. For an inherited IRA, the holders are:
- Not allowed to make additional contributions to the account
- Required to withdraw funds regardless of whether they have reached retirement age
- May withdraw assets at any time without an income tax penalty
Given these distinctions, the Supreme Court ruled that “funds held in such account are not objectively set aside for the purpose of retirement.” Experts on the subject have concerns about whether spousal rollovers continue to be exempt from creditors as well.
Some Planning Opportunities Remain
Going forward, inherited IRAs have fewer creditor protection characteristics. However, there are still planning opportunities available under some state creditor exemptions or by naming a qualified trust as the beneficiary.
If a trust is used as a beneficiary of an IRA, the trust must be drafted properly. The trust can help shield trust assets from creditors. Adding a trust as the beneficiary can make the process more complex and add additional costs to create and administer the trust. Also additional income tax burdens may exist, depending on the trust’s terms.
Overall, this ruling is particularly important if you own a significant IRA account or if you inherit an IRA. Have a conversation with your advisors to review all the rules before making beneficiary designations or transferring balances after someone’s death.
Ohio Tax Assistance
If you have questions and/or concerns about your retirement options, contact Rea & Associates. Our team of Ohio tax professionals can help you determine if the inquiry is legitimate, and assist you with responding.
Author: Wendy Shick, CPA, CFP (Mentor office)
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