Protecting Inherited IRAs From Creditors

Question:  What protection, if any, do I have now that the Supreme Court has ruled that IRAs are not exempt in bankruptcy?

Answer:  In Clark v. Rameker, the U.S. Supreme Court ruled that inherited individual retirement accounts (“IRAs”) do not qualify for the Federal exemption when the beneficiary of the inherited IRA files for bankruptcy.  As such, the holder of an inherited IRA cannot exclude such assets from the trustee of the beneficiary’s bankruptcy estate. Clark only applies to inherited IRAs which are IRAs held by the non-spouse beneficiary of a deceased IRA owner.  Because inherited IRAs do not include IRAs paid to the IRA owner’s surviving spouse, a surviving spouse holding IRA assets he or she received from a deceased spouse can utilize the Federal bankruptcy exemption for retirement plan assets if the spouse files for bankruptcy.  Also, the Clark decision does not affect the bankruptcy exemption for IRA owners themselves; the decision only affects IRAs paid to a non-spouse beneficiary on the IRA owner’s death. 

Some states provide bankruptcy protection for inherited IRA assets such that a recipient of IRA assets may benefit from protections afforded by State laws.  Nevertheless, given the transience of today’s population, reliance on State laws for this purpose may ultimately not provide the desired protection.

IRA owners who intend to pass their individual retirement accounts to non-spousal beneficiaries must be mindful of the claims the beneficiary’s bankruptcy trustee can make against such assets.  Passing inherited IRA assets in trust for the intended beneficiary can overcome the impact of Clark as trusts can be created to hold assets which are outside the reach of the trust beneficiary’s prospective bankruptcy trustee.  Having IRAs paid to a properly-designed trust for a beneficiary as opposed to being paid to the beneficiary directly is an obvious asset protection technique which should be strongly considered.

Most IRA assets hold pre-tax funds, funds which have not previously been subject to income tax; the taxable event occurs when funds are withdrawn from an IRA.  When IRA funds are withdrawn and distributed to trust beneficiaries, the IRA distribution will be taxed to the trust if the income is retained by the trust or taxed to the beneficiary if the income is distributed by the trust to the beneficiary.  Because of the compressed income tax brackets applicable to trusts, trust income is generally taxed at a higher rate than individual income.  Accordingly, a trust’s distribution of income to its beneficiary can minimize the overall impact of tax on the IRA distribution.  Trusts can also be designed to enable the trust beneficiary to take advantage of prolonged distributions available to IRA recipients.  The so-called “stretch” distribution rules which permit an IRA beneficiary to receive distributions over the beneficiary’s lifetime will still be available to a trust beneficiary if the trust is properly designed. 

The Clark decision no doubt deals a blow to non-spouse beneficiaries of IRA assets.  For those IRA owners who wish to protect their beneficiaries in the unfortunate event of bankruptcy, proper planning can overcome the impact of the recent Supreme Court decision.


The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter, you may contact Bruce at (312) 648-2300 or send an e-mail to [email protected].

CIRCULAR 230 Notice:  In order to comply with requirements imposed by the Internal Revenue Service, we wish to advise you that (a) any U.S. federal tax advice contained in this communication is not intended and cannot be used for the purpose of avoiding tax-related penalties, and (b) no one, without prior written consent, may use any advice contained in this transmission in promoting, marketing, or recommending any entity, investment plan, or arrangement to another taxpayer.

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