This past summer in Clark v. Rameker, the Supreme Court ruled unanimously that inherited IRAs are not retirement funds and thus are not protected during bankruptcy proceedings. This decision will have a clear impact on estate planning because IRAs passed onto heirs are no longer protected like they once were, and spouses who receive IRAs after death must now make a decision regarding IRA rollover.

In Clark v. Rameker, Heidi Heffron-Clark inherited an IRA after her mother passed away in 2001. In 2010, she and her husband filed for bankruptcy and intended to shield this inherited IRA from creditors by counting it as retirement funds. In the past, courts have allowed heirs to do this, but in a stunning reversal, the Seventh Circuit Court of Appeals and the Supreme Court ruled that inherited IRAs cannot be counted as retirement funds and cannot be shielded during bankruptcy.

In its decision, the Supreme Court asserted that inherited IRAs do not function the same way as IRAs that you set up yourself, and so they should not have the same legal protections. The Court explained that inheritors cannot add funds to inherited IRAs, inheritors must begin to withdraw from the IRA even if they are not close to retirement, and inheritors can take large distributions from the IRA at any time and without penalty. Because of these three differences, the Supreme Court argued that inherited IRAs are not like normal IRAs and do not function as retirement funds, so they will not be afforded the same protections. Individuals should now adjust their estate plans accordingly because transferring IRAs to heirs will no longer be as beneficial as in the past.

Spouses Who Inherit IRAs

Unlike other individuals who inherit IRAs, spouses have the option to roll over the IRA into their own existing IRA. In the past, surviving spouses often had no reason to roll over because they could just maintain both IRAs and be confident that both would be protected during bankruptcy. With the new Supreme Court decision, surviving spouses should seriously consider rolling over their inherited IRAs. According to Investment News, the spouses may have to pay 10% early withdrawal penalty if the funds are transferred before they turn 59.5 years of age. However, in many cases this penalty is worth it in order to protect those funds in the case of bankruptcy.

Protecting IRAs for Non-Spouse Heirs

Although the Supreme Court has taken away the primary protection for inherited IRAs, there is still a way for estate planners to make sure that these IRAs are protected from bankruptcy proceedings. According to Forbes, by naming trusts as the beneficiaries of IRAs instead of naming people, these funds can still be available to your loved ones after you pass away and can still retain their prior protections. Of course, establishing trusts is a much more complex process, so individuals should make sure they want to take this route and should seek the advice of estate planning experts.

Clark v. Rameker has changed the rules regarding inherited IRAs and made them a less attractive asset to pass on to your spouse or children, but it’s important to remember that with rollovers and trusts you can still protect these assets and make them available to your loved ones.

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