One of the non-tax advantages of qualified plans is that they are not subject to being claimed by any creditors. If a taxpayer has financial troubles before retirement, they may lose other, individually owned assets, but qualified individual retirement accounts (IRA) cannot be touched. However, once the money has been distributed from the plan, they may be claimed just like any other asset. Apart from bankruptcy, an IRA is not subject to the anti-assignment provision that applies to qualified plans.
In June of this year, the U.S. Supreme Court ruled in Clark v. Rameker that inherited IRAs are not exempt from bankruptcy claims because they are not retirement funds. This decision mirrored the decisions from Bankruptcy and Seventh Circuit courts – they are not considered retirement funds because they were inherited from another individual. This decision adds another dimension to the beneficiary designation. By naming an individual to a beneficiary, the taxpayer does open the entire IRA to potential loss if the beneficiary has (or has in the opinion of the taxpayer) a high probability by reason of lifestyle to have creditor problems. The best way to avoid this is to designate a trust as the beneficiary with the individual named as the beneficiary of the trust. The trust may then provide a spendthrift clause that will protect the assets from the claims of creditors of its beneficiary. This will limit the amount a creditor may pursue.
This decision is, however, in contrast to a decision by the District Court, which said the funds were originally accumulated for retirement purposes and should retain that character in the hands of the successor. The ruling of the U.S. Supreme Court is clear – retirement funds lose that characteristic upon the death of the original owner. The beneficiary may not contribute to the inherited IRA even if the beneficiary is otherwise eligible to do so. The beneficiary can take distributions at anytime without penalty that would apply to their own traditional IRA. This decision does not change the law with respect to traditional or Roth IRAs.
Need to brush up on the IRA rules and regulations? Surgent discusses these issues in the Best Individual Income Tax Update Course. The course is offered in both self-study and webinar formats.
