IRAs and Estate Planning

In 2014, the U.S. Supreme Court’s decision in Clark v. Rameker altered the landscape of estate planning strategies concerning protecting inherited IRAs from creditor claims. In Clark, the court considered whether a person who had inherited an IRA from her mother and filed for bankruptcy nine years later, whether creditors could access the funds in the IRA to satisfy their claims as the funds were not earmarked exclusively for retirement. Historically the Bankruptcy Code provide an exemption to allow debtors to protect certain IRA funds needed to meet their basic retirement needs. The Clark court considered whether the scope of this exemption reached an inherited IRA. The Court held in a unanimous decision that a beneficiary’s interest in an inherited IRA was not exempted by the Bankruptcy Code and therefore could be used to satisfy creditor claims. According to the Clark Court, a beneficiary’s interest in an inherited IRA does not fall under the exempted status granted to “retirement funds” under the Bankruptcy Code. The court reasoned that since the beneficiary of an inherited IRA may not invest additional money in the account, is required to withdraw money from the account regardless of their age, and the fact that the beneficiary may withdraw the entire balance of the account at any time and for any purpose without incurring the 10% penalty tax that applies to early withdrawals, these funds should not be considered funds necessary for future retirement, but rather “a pot of money that can be freely used for current consumption.” Given its status as a readily available source of money, creditors can rightfully access these funds. In light of this development, estate planners will need to consider alternative methods to protect a beneficiary’s interest from bankruptcy creditor claims.

One of the first questions estate planners may have in light of the Clark decision involves whether the court’s definition of “retirement funds” extends to tax-qualified retirement plans and other types of tax-favored retirement accounts. Although this question was not expressly addressed in the case, it appears that a beneficiary’s interest in other types of tax-favored retirement funds may be affected. Therefore, estate planners should consider other methods to transfer assets to beneficiaries that could not potentially invoke the Clark decision. For example, one interpretation of Clark applies to a spouse who inherits an IRA that may fall under the Clark decision thereby subjecting it to claims from bankruptcy creditors. However, other opinions on this topic state that a spouse who inherits an IRA can roll the funds into their own IRA and avoid exposing these assets to bankruptcy creditor claims.

One suggested method to avoid any potential traps that could arise from directly transferring an IRA to a beneficiary involves transferring IRA assets to an irrevocable trust. By transferring IRA funds into a trust, an estate planner can potentially reduce beneficiaries’ exposure to risks, and offer more control over distributions to beneficiaries from IRA funds.

Counsel experienced in estate planning, specifically the transfer of tax qualified retirement plans to beneficiaries can assist an individual or their families in the asset preservation strategies.

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