Are Inherited IRAs Protected from Creditors?

Among their many benefits, qualified retirement plans are protected from claims by creditors. However, the Supreme Court unanimously ruled last month that inherited IRAs are not retirement accounts and, therefore, not protected from creditors. The high court’s ruling agrees with several states that previously ruled that inherited IRAs are not retirement plans.

When a beneficiary inherits an IRA, they receive the assets of that IRA in an account called an “inherited IRA.” The Supreme Court likely reasoned that because IRA beneficiaries did not save the funds themselves, but rather inherited them, the inherited IRA should not be protected from creditors.

According to IRA Guru Ed Slott, these are the details of the case: Ruth Heffron named her daughter, Heidi Heffron-Clark, as her IRA beneficiary. In 2001, Ruth died and Heidi inherited the IRA. In 2010, Heidi and her husband filed for bankruptcy when the inherited IRA was worth about $300,000. They claimed the inherited IRA as an exempt asset consisting of “retirement funds” as prescribed by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. However, their creditors questioned whether the term “retirement funds” included inherited IRAs, since the IRA was not Ruth’s retirement account, but her mother’s. The primary issue before the Supreme Court was whether or not an inherited IRA is a retirement account.

Slott also notes that the high court cited several characteristics of inherited IRAs that are not characteristics of “retirement” accounts:

  • Beneficiaries cannot add money to inherited IRAs in the way IRA owners can to their own accounts.
  • Beneficiaries of inherited IRAs must generally begin to take required minimum distributions in the year after they inherit the account, regardless of how far away they are from retirement.
  • Beneficiaries can take total distributions of their inherited accounts at any time and use the funds for any purpose without a penalty.

Importantly, the Supreme Court’s ruling does not mention anything about spouses who inherit an IRA. However these “spousal IRAs” also have different rules than IRAs, so their protection may also be challenged one day.

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