Inherited Retirement Funds Are Not Protected in a Bankruptcy

Question: If you inherit an individual retirement account (IRA) but then declare bankruptcy, what happens to that IRA?

Answer: In a 2014 U.S. Supreme Court case, Clark v. Rameker, a daughter inherited an IRA from her mother but then declared bankruptcy. Under federal law, certain assets are considered protected assets, one of those being IRAs. However, the Supreme Court ruled that inherited IRAs are not “retirement funds” within the meaning of federal bankruptcy law. The Court focused on three differences between participant-owned IRAs and inherited IRAs to make their decision:

1. The owner of an IRA can make additional contributions to the account while the beneficiary of an inherited IRA cannot.

2. The owner of an IRA can defer distributions at least until he/she is 70.5 years old while the beneficiary of an inherited IRA must take required minimum distributions from the account regardless of how far away the beneficiary is from actually retiring.

3. The owner of an IRA must generally wait until he/she is at least 59.5 years old to take penalty-free distributions while the beneficiary of an inherited IRA can withdraw all of the funds at any time and for any purpose without a penalty.

These three main differences highlight why inherited IRAs are not protected in this situation – because the money was originally set-aside for the owner’s retirement rather than the beneficiary’s inheritance. The implications of this decision has far-reaching implications because its logic would affect all inherited defined contribution retirement plan accounts, such as 401(k) and 403(b) accounts. The Clark decision has highlighted the need for knowledgeable estate attorneys to highlight the pros and cons of all of the choices a person has for designating what to do with their retirement assets, especially for those who may inherit them. With the collaboration of Kieu-Nhi Le, Rutgers School of Law Newark candidate for a JD degree in May 2016. She is the Managing Business Editor of the Rutgers Computer and Technology Law Journal.