How to Protect Inherited IRAs After the Clark Decision

In a landmark, unanimous decision handed down on June 12, 2014, the United States Supreme Court held that inherited IRAs are not “retirement funds.”

This ruling is important to you and your family because it means you need to take action to ensure your retirement funds are protected when they pass to the next generation – and, perhaps, even to your spouse.

Here’s what happened in the Clark Case:

Ruth Heffron created an IRA, naming her daughter, Heidi Heffron-Clark, as beneficiary. After Ruth died, Heidi transferred the IRA assets (approximately $300,000) into an “Inherited IRA.”
Some nine years later, Heidi and her husband, Brandon, filed bankruptcy and sought to protect the Inherited IRA from their creditors. The couple argued that the inherited IRA assets were protected retirement funds. Both the bankruptcy trustee and the judgment creditors objected.

The case went all the way to the United States Supreme Court, which ruled that funds held within an inherited IRA are not “retirement funds.” And, as a result, those funds have no protection as retirement funds and can be seized to pay off debts to creditors.

The Court reached its conclusion using three (3) elements, which differentiate an inherited IRA from a participant-owned IRA:

1. The beneficiary of an inherited IRA cannot make additional contributions to the account, while an IRA owner can make contributions.
2. The beneficiary of an inherited IRA must take required minimum distributions from the account, regardless of how far away the beneficiary is from actually retiring, while an IRA owner can defer distributions at least until age 70 ½.
3. The beneficiary of an inherited IRA can withdraw all of the funds at any time and for any purpose without a penalty, while an IRA owner must generally wait until age 59 1/2 to take penalty-free distributions from an IRA

This decision and analysis by the U.S. Supreme Court has sent shock waves through the estate planning and financial advisory worlds. The logic of the Court is easily extended to all inherited defined contribution retirement plan accounts, so inherited 401(k) and 403(b) accounts are also affected.

What Can Be Done to Protect Inherited IRAs from Creditors?

In light of the Clark decision, clients must thoughtfully reconsider any outright beneficiary designations. By far, the best option for protecting an inherited IRA is to create a Retirement Plan Trust. When properly drafted, this a Retirement Plan Trust offers the following advantages:

• Protects the inherited IRA from beneficiaries’ creditors, predators, as well as current and future lawsuits
• Ensures that the inherited IRA remains in the family bloodline and out of the hands of a beneficiary’s spouse, or soon-to-be ex-spouse
• Allows for experienced investment management and oversight of the IRA assets by a professional trustee and investment advisor, if desired
• Prevents the beneficiary from squandering away an inherited IRA, allowing IRA distributions to be received over the lifetime of a beneficiary
• Enables proper planning for a special needs beneficiary to avoid disqualification from receipt of valuable government benefits
• Facilitates transfer tax planning to ensure estate taxes are minimized, or potentially eliminated, when inherited IRA assets pass to grandchildren

Could State Law Still Protect Inherited IRAs?

A handful of states – including Alaska, Arizona, Florida, Idaho, Missouri, North Carolina, Ohio and Texas – have either passed laws or had favorable court decisions that specifically protect inherited IRAs under state bankruptcy statutes. If the IRA beneficiary is lucky enough to live in one of these states, then that beneficiary may very well be able to protect their inherited retirement funds by claiming the state law exemption instead of the federal law exemption.

Caution:  Caution should be used in relying upon state law to protect a beneficiary’s inherited IRA. In general, people are more mobile than ever and your beneficiary may need to move from state to state to find work, pursue educational goals, or be closer to family members.  In addition, federal bankruptcy laws now require a debtor to reside in a state for at least 730 days to use state bankruptcy exemptions. Therefore, long-term planning should not rely on a specific state law but instead should take a broad approach to asset protection planning strategies.

The Bottom Line

If you have significant tax-deferred retirement plan accounts, please call The Levin Law Firm at (610) 977-2443 to arrange a complimentary consultation regarding your particular situation.

We can show you how to protect your tax-deferred assets from your beneficiaries’ creditors, divorcing spouses, frivolous lawsuits, medical crises, and spendthrift tendencies. It is imperative that you take action now to learn about estate planning strategies to protect your IRA assets.