The Supreme Court in a unanimous decision ruled on June 12, 2014, that inherited IRAs are subject to creditors and are not protected in bankruptcy. The ruling brings clarity to an issue – whether or not inherited IRAs are protected – that had been split among the circuit courts.
The ruling does not mean that with proper planning, an inherited IRA cannot be protected from creditors. It just takes a little foresight in the planning.
It is important to understand that a spouse may still protect retirement assets from creditors by rolling over retirement assets into their own IRA, rather than an inherited IRA. Only surviving spouses are allowed this treatment, and by rolling over the assets, the bankruptcy protection remains. A spousal IRA is treated exactly the same as a typical IRA in that the surviving spouse may continue to make annual contributions, the surviving spouse may take minimum required distributions over the surviving spouse’s life expectancy, and the surviving spouse is not required to take minimum required distributions upon the death of the first spouse, but rather they can wait until age 70 ½ (for a traditional IRA). An inherited IRA does not allow continued contributions and requires minimum required distributions immediately. Generally, surviving spouses find that rolling over retirement assets is the best course of action. The Supreme Court’s ruling strengthens the spousal rollover IRA even more.
Non-spouse beneficiaries may still protect inherited retirement assets from creditors, but the original retirement plan or IRA owner will need to properly plan for this treatment. A parent with an IRA and a child with creditor issues should consider leaving the IRA to a trust for the child’s benefit rather than outright to a child. The parent can establish a conduit trust to hold the retirement plan assets, the trustee must distribute the minimum required distribution to or for the benefit of the child each year, but the entire balance cannot be attached by creditors. Further, the trustee may use the minimum required distribution for the benefit of the beneficiary, and is not required to give the child cash.
While the Supreme Court’s ruling solidifies that inherited IRAs are not protected in bankruptcy, with proper planning, an individual may protect retirement plan assets for their beneficiaries.