U.S. Supreme Court Ruling Finds Inherited IRAs Not Protected In Heir's Bankruptcy

Recently, the U.S. Supreme Court unanimously ruled that the U.S. Bankruptcy Code does not protect funds in an inherited individual retirement account (“inherited IRA”) from a creditor’s claims in the heir’s bankruptcy. The case, Clark v. Rameker, involved petitioners Brandon Clark and Heidi Heffron-Clark who declared bankruptcy in 2010 after their pizza restaurant closed in their hometown of Stoughton, Wisconsin.

In 2000 Ruth Heffron established an IRA naming her daughter, Heidi Heffron-Clark, as the designated beneficiary of her IRA. At Mrs. Heffron’s death in 2001, the IRA had a value of $450,000.

When daughter Heidi filed a Chapter 7 bankruptcy petition in October 2010, the IRA had a value of $300,000. She asserted in her petition that the money in the inherited IRA represented “retirement funds” that were protected from creditor claims. The U.S. Supreme Court rejected her argument and held that assets retained in inherited IRAs are not “retirement funds” within the meaning of the federal bankruptcy laws and therefore are subject to the claims of bankruptcy creditors.

In reaching its conclusion, the Court noted that inherited IRAs are different from traditional IRAs and Roth IRAs because (i) the beneficiary-owner may not contribute additional funds to an inherited IRA, (ii) the assets of the inherited IRA must be withdrawn immediately or over a period years and cannot be retained pending the beneficiary-owner’s future retirement and (iii) unlike a traditional IRA, which imposes a penalty if the owner begins to take withdrawals prior to attaining age 59½, the beneficiary-owner of an inherited IRA may withdraw all or any portion of the assets immediately without penalty.

A Court distinguished a traditional IRA inherited by a spouse from an “inherited IRA.” A surviving spouse can roll the traditional IRA over into a separate IRA in his or her own name. It is not clear how the Court would rule in the event a surviving spouse fails to make such a rollover.

Ruth Heffron probably never gave a second thought to how she should structure her IRA account to protect Heidi in the event of financial problems down the road. Had Ruth designated an irrevocable trust established for Heidi’s benefit as the primary beneficiary of her traditional IRA (instead of designating her daughter individually), Heidi may have been able to protect the inherited IRA funds from her bankruptcy creditors, saving her a lot of dough!

At BWM&S we encourage our friends and clients to review their primary estate planning documents, including the beneficiaries of their retirement plan accounts and insurance policies, at least every two years. If you have not had a chance to speak with your attorney about how the Clark v. Rameker case impacts your estate plan, we recommend that you do so.

Please contact Jonathan Michael at jmichael@burkelaw.com or 312/840-7049 with any questions regarding estate and business succession planning, including the implications of Clark v. Rameker.