Jun 16, 2014

U.S. Supreme Court Holds that Inherited IRAs are Not Exempt from Bankruptcy

On June 12, 2014, the U.S. Supreme Court, in a unanimous decision, ruled that “inherited” Individual Retirement Accounts (“IRAs”) are not protected from creditors in bankruptcy proceedings. As background, the general rule in bankruptcy has been to treat retirement funds, such as IRAs, as exempt from claims of creditors in bankruptcy. However, the Court held that the ordinary meaning of “retirement funds” is money set aside for individuals when they stop working. Therefore, inherited IRAs may be reachable by an individual’s creditors in the event of bankruptcy.

Justice Sotomayor, writing for the Court, stated that unlike a traditional or Roth IRA, an individual may withdraw funds from an inherited IRA at any time, without paying a tax penalty, and they should not be considered “retirement funds.” Justice Sotomayor listed three characteristics of inherited IRAs that provided evidence that inherited IRAs do not contain retirement funds.  First, the owner of an inherited IRA is never allowed to invest additional funds into the inherited IRA.  Second, owners of inherited IRAs are required to withdraw money from the accounts, no matter how far they are from retirement. The owner must either withdraw the entire balance in the account within five years of the original owner’s death or take minimum distributions on an annual basis based on the owners’ age. Third, the owner of an inherited IRA may withdraw the entire balance of the account at any time without a penalty. Therefore, Justice Sotomayor held that inherited IRAs may be subject to creditors’ claims in bankruptcy.

This ruling resolves a current split among the circuits on this issue and will likely have a far-reaching impact upon retirement and estate planning for clients.

For a copy of the Court’s opinion, click here.

For more information on inherited IRAs, please contact your Executive Compensation and Employee Benefits Counsel at Smith, Gambrell & Russell.

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