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Supreme Court Ruling Puts Inherited IRAs at Risk in Bankruptcy Proceedings

06.16.14


The United States Supreme Court ruling in Clark v. Rameker could have an impact on what are sometimes an individual’s most significant legacy assets: individual retirement accounts, or “IRAs.” A participant’s IRA is generally afforded protection in bankruptcy proceedings. The Clark ruling on June 12, 2014, however, clearly provides that this bankruptcy protection does not extend to the IRA beneficiary following the participant’s death, unless the beneficiary is a surviving spouse who elects to “roll-over” the IRA.

Upon the death of an IRA participant, the remaining IRA balance is distributed to the beneficiaries designated by the participant. With respect to a beneficiary other than a spouse, the beneficiary is deemed to receive an inherited IRA. A benefit of an inherited IRA is that the beneficiary may withdraw funds therefrom prior to age 59½ without penalty. However, spouses who are the designated beneficiary have two options regarding the IRA; they may simply do nothing, in which case they will be deemed to have received an inherited IRA, or they may elect to “roll-over” the participant’s IRA to their own IRA. Following a roll-over, all funds held in the surviving spouse’s IRA (including those rolled over) will be administered as part of the surviving spouse’s IRA and subject to the regular IRA rules (e.g., early withdrawal penalty). In light of Clark, IRA participants should carefully consider their beneficiary designations if a potential beneficiary is, is expected to be, or perhaps at some point in the future may be in financial distress.

Prior to Clark, it was unclear whether funds in an inherited IRA were protected in bankruptcy proceedings. The Fifth Circuit Court of Appeals, as well as a number of bankruptcy courts across the country, had held such funds were protected while the Seventh Circuit Court of Appeals declined to extend similar protection. In Clark, the Supreme Court held inherited IRA funds were not afforded any bankruptcy protection. The Clark opinion, however, indicates the funds in a surviving spouse’s IRA which are attributable to a roll-over remain entitled to such protection.

The Supreme Court’s Clark decision could have a substantial impact on selecting the appropriate designated beneficiaries of an IRA. Since the IRA will be not be afforded protection in a bankruptcy proceeding of a non-spouse beneficiary, a participant who is concerned about the potential financial stability of the intended beneficiary should consider designating a trust for the benefit of the intended beneficiary, rather than the beneficiary individually. While the rules for ensuring there is no income tax difference between naming the beneficiary directly versus a trust are complex, the bankruptcy protection afforded by this approach could be significant. Moreover, with respect to a beneficiary who is a spouse, the Clark decision is another factor to be considered in deciding whether to take the IRA as an inherited IRA versus a rollover to their own IRA.

For more information, please contact Aaron Flinn, Leigh Griffith, or any member of the Waller Tax team at 800.486.6380.



The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance.

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