As a result of the Supreme Court’s recent decision in Clark v. Rameker, IRA assets inherited by a nonspouse beneficiary are no longer protected from creditors in a bankruptcy proceeding.
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act extended bankruptcy protection to “retirement funds,” shielding traditional and Roth IRAs up to an inflation-adjusted one million limit (adjusted to $1,242,475 in 2013). Soon, however, bankruptcy trustees began challenging the idea that the term “retirement funds” included inherited IRAs. After various courts weighed in on this issue, the Supreme Court settled the matter with the Clark decision.
What could this mean for you?
It’s important to note that the Court’s ruling applies to IRAs inherited by someone other than a spouse; the rules for spousal IRA beneficiaries remain the same.
- IRAs inherited by a spouse. A surviving spouse can either maintain the deceased spouse’s IRA as a separate account or roll it into his or her own IRA. If the IRA is rolled over, the account funds will be treated as “retirement funds,” and the surviving spouse (1) can’t withdraw any funds before age 59½ without paying a penalty tax, and (2) must begin taking withdrawals by the time he or she reaches age 70½.
- IRAs inherited by a nonspouse. As the Court pointed out, IRAs inherited by other beneficiaries differ in a number of ways from those inherited by a spouse. While the funds remain sheltered from taxation until the money is withdrawn, no new contributions can be made to the account, and the balance can’t be rolled over or merged with any other account. In addition, the inherited IRA must begin distributing its assets within a year of the original owner’s death. Based on these distinctions, the Court ruled that IRAs inherited by nonspouse beneficiaries are no longer considered “retirement funds” for bankruptcy purposes.
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