Bankruptcy courts have typically held that inherited individual retirement accounts (IRAs) are not subject to creditor’s claims in bankruptcy proceedings. However, that has all changed. In the case of Clark v. Rameker, June 12, 2014, the Supreme Court held that funds in an inherited IRA aren’t “retirement funds” under the Bankruptcy Code and are therefore not entitled to be protected during a bankruptcy proceeding from creditors.
In 2001, Heidi Clark inherited her mom’s IRA valued at $293,338. Rather than cash-out the IRA, Heidi and her husband continued to take the required minimum distributions (RMDs) and to stretch the account – a smart investment decision. In 2010, she and her husband filed bankruptcy and attempted to exempt the IRA from creditor’s claims. The bankruptcy court ruled against the Clarks. The decision marked only the second time in history that a bankruptcy judge had reached that decision. The bankruptcy court’s holding was later reversed by the District Court for the Western District of Wisconsin, then heard again in the Seventh Circuit, before making its way to the U.S. Supreme Court which ruled in favor of the Clark's creditors.
There are significant tax advantages to leaving your IRA to your adult children. However, due to the holding in this case, if you have any concerns about your children’s future financial stability, you may want to consider naming a trust as the beneficiary of the IRA. A properly prepared trust can provide protection from your children's potential future creditors, including in the event of bankruptcy.
To learn more about protecting your children's inheritance, click here.