Inherited IRAs – Are They Protected?

After a recent U.S. Supreme Court ruling, Clark v. Rameker, many fear their inherited individual retirement accounts may not be protected from creditors in bankruptcy. Fortunately, for those living in Ohio, this ruling may not impact you. When Congress created the federal bankruptcy exemptions, it also gave permission to the states to create their own exemption systems and opt out of the federal exemption system.  Ohio chose to opt out and apply its own exemption system.  In Rameker, the Supreme Court analyzed the relevant federal bankruptcy exemption, which is quite different from Ohio’s exemption.

iraCurrently, if you live in one of the following states, you can choose to use the federal bankruptcy exemptions.  If not, then you are limited to your state’s exemptions.  These states include Alaska, Arkansas, Connecticut, District of Columbia, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin. States that utilize the federal exemption, and states with statutes that resemble the federal statutes, may be impacted by the Supreme Court’s decision.

In this case, a daughter inherited her deceased mother’s traditional IRA, as sole beneficiary. The daughter elected to take monthly distributions from the IRA.  Later, the daughter filed a bankruptcy petition under Chapter 7. In the petition, she sought to exempt the inherited IRA from her bankruptcy estate as a retirement fund y applying the federal exemption statute. The bankruptcy trustee and the unsecured creditors objected, arguing that the funds in the inherited IRA were not “retirement funds” and therefore could not be exempted from the bankruptcy estate under that provision. The bankruptcy court agreed.

After the lower courts issued conflicting decisions, the Supreme Court took the case to resolve the question of whether an inherited IRA was exempt. Under the Bankruptcy Code, a debtor may protect assets that are both (1) retirement funds and (2) exempt from income tax under one of several specified Internal Revenue Code provisions, including IRC section 408 which provides a tax exemption for IRAs.  But does an inherited IRA qualify for this creditor protection?  A unanimous Supreme Court recently held that inherited IRAs do not qualify for a federal bankruptcy exemption and are not protected from creditors in bankruptcy.

In reaching its decisions, the Supreme Court focused on the meaning of “retirement fund.”  The Court stated that “retirement fund” refers to money that is set aside to be used at a time when the person is no longer working. The Court found that the determination of whether funds held in an account are “retirement funds” should be based on the legal characteristics of the account holding the funds, and on whether the account is one that was created by an individual for use by that individual at a time when the individual was no longer working.

In Ohio, however, this analysis should not apply. Ohio Revised Code § 2329.66(1)(e)[1] specifically provides an exemption for inherited IRAs so the Supreme Court’s analysis of the federal exemption provided by 11 USC 522(b)(3)(C) shouldn’t apply. That said, you should consult an attorney to determine whether this new ruling impacts your estate planning and take the necessary steps to protect your assets.  If you have any questions about this post or your unique situation, please contact Joshua Kin or Jeff Senney at 937-223-1130.

AND ONE MORE THING.  It is important to note is that a spousal beneficiary of a decedent’s IRA has the option of treating the IRA as his or her own IRA, rather than being subject to the general rules for “inherited IRAs.” When such an election is made, the surviving beneficiary spouse, as IRA owner, may defer the start of lifetime IRA distributions to his or her required beginning date.

AUTHOR: Jeff Senney