In June 2014, the Supreme Court ruled unanimously that individual retirement accounts (IRAs) inherited by a taxpayer are not protected in bankruptcy proceedings. In the case of Clark v. Rameker the courts have acknowledged that, while bankruptcy code is intended to protect the retirement accounts of debtors, it is not intended to protect inherited IRAs.
Three key factors distinguish traditional IRA accounts from inherited IRA accounts: :
The Supreme Court decision effectively confirmed that the inherited IRA funds are freely consumable by the beneficiaries and, therefore, should not be treated as retirement funds under the bankruptcy exemption.
Since the court’s decision onJune 12th, many financial advisors are helping their clients design strategies that minimize income tax liability and protect their assets.
While many experts believe that the ruling will not apply to spousal beneficiaries who can roll the inherited IRA accounts over to their own name, some believe that the courts will eventually challenge the exemption of spousal rollovers, making the funds subject to bankruptcy creditors.
Where federal exemption is not available, some bankruptcy debtors may seek protection from state laws. Several states, including Alaska, Arizona, Florida, Missouri, North Carolina, Ohio, and Texas, have adopted laws officially exempting inherited IRA accounts from bankruptcy.
For individuals who do not want to rely on state laws or do not reside in such jurisdictions, estate planning attorneys recommend the alternative use of a trust as the beneficiary of an inherited IRA. In fact, some believe that the accumulation trust will become a popular option, from an asset protection standpoint, as the trustee can opt to hold the funds and not make the distributions. The downside, of course, is that accumulating the distributions at the trust level will have less favorable tax treatment, since the top tax bracket (39.6%) for trusts in 2014 will be reached at just $12,500 of taxable income.
For majority of beneficiaries, the risk of liability and creditors may be low, but a conversation with advisors should be considered if asset protection is the ultimate priority.
For more information about the tax issues surrounding IRAs or other retirement accounts, please contact your Aronson tax advisor or Anatoli Pilchtchikov at 301.231.6200.