Individual Retirement Accounts are considered to be exempt retirement funds within the meaning of the federal bankruptcy law. However, in a unanimous decision, the Supreme Court recently held that inherited IRAs do not qualify for protection from creditors in bankruptcy. An inherited IRA is just what the name indicates, an IRA inherited from anyone except a spouse.
When drafting its decision the Court focused on three issues:
- The owner of an inherited IRA is prohibited from making additional contributions to the account;
- The owner of an inherited IRA is required to take distributions from the account regardless of whether they have retired or not; and
- The owner of an inherited IRA can withdraw the money at any time (e.g., before age 59 1/2) and not incur a penalty.
Based on these differences between an inherited IRA and a traditional IRA, the court held that an inherited IRA did not qualify as a retirement fund for bankruptcy purposes.
This ruling needs to be taken into account when you are selecting IRA beneficiaries. Consider designating a spendthrift trust as the beneficiary of the IRA and not your heirs individually. In this way, the IRA funds will be protected from the heirs’ creditors.