We have written on the question whether inherited IRAs are exempt from creditors in a federal bankruptcy action here, here, and here. The various courts that have addressed the issue have gone in both directions.
The U.S. Supreme Court has now weighed in, and has ruled that inherited IRAs are not exempt from bankruptcy creditor claims.
The Court analyzed the issue as to whether inherited IRAs are enough like regular retirement assets (i.e., sums set aside until one stops working) to be entitled to the standard IRA exemption. It did so in an attempt to balance the interests of creditors and debtors, by giving only protection to those accounts that have enough “retirement fund” characteristics.
The Court found that certain key aspects of inherited IRAs are not like a retirement asset. In particular, the Court noted (a) inherited IRA holders cannot add new assets, (b) required distributions did not turn on whether the holder has reached retirement age, and (c) holders can withdraw from the IRA without penalty at any time. Thus, it is improper to allow an exemption.
The Court held:
For if an individual is allowed to exempt an inherited IRA from her bankruptcy estate, nothing about the inherited IRA's legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete. Allowing that kind of exemption would convert the Bankruptcy Code's purposes of preserving debtors' ability to meet their basic needs and ensuring that they have a “fresh start,” Rousey, 544 U. S., at 325, into a “free pass,”
This does not mean inherited IRA benefits cannot be protected against creditors of the recipient. Through the use of trusts and applicable spendthrift and other trust protections that exist under applicable state law, inherited IRA proceeds can be protected by leaving them to trusts instead of outright to the recipients. Of course, planning for such trusts will need to coordinate with the IRA rules for allowance of deferral of required distributions, to the extent such deferral is desirable or otherwise available.
CLARK v. RAMEKER, 113 AFTR 2d 2014-XXXX, (S Ct), 06/12/2014