The unanimous June ruling by the Supreme Court of the United States in Clark v Rameker, has the potential to affect how millions of Americans plan their estates, as the decision changed the bankruptcy status of inherited IRAs.
The Court held that while the Bankruptcy Code exempts qualified retirement plans, IRAs and similar “retirement funds,” the bankruptcy exemption does not extend to an inherited IRA.
Prior to the ruling, inherited IRAs were considered “retirement funds” and were protected from bankruptcy proceedings. Using an IRA was a simple way for people to protect their estate.
All the justices agreed that inherited IRAs did not meet the criteria to be qualified as “retirement funds.” The National Consumer Bankruptcy Center offers an excellent explanation of Justice Sonia Sotomayor’s majority opinion:
The opinion focused on differences in…inherited IRAs which go to a surviving spouse and those that go to someone other than the spouse. A spouse has the option of rolling over the funds into a new IRA, treated like any other IRA, but a non-spouse is limited to treating the funds according to rules applicable only to inherited IRAs.
Federal Ruling May Not Affect All States
Since the Supreme Court decision only applies to federal bankruptcy court, there might be opportunity for protection depending on your state’s bankruptcy laws. Investment News explains it this way:
[The ruling] does not, however, preclude states from offering bankruptcy protection — or, for that matter, creditor protection in non-bankruptcy situations — to inherited IRAs under state law. In fact, to date seven states have adopted laws expressly exempting inherited IRAs under state bankruptcy statutes. Those states are Alaska, Arizona, Florida, Missouri, North Carolina, Ohio and Texas.
For many in the US, an IRA can make up a significant portion of their overall estates. Long-term, the decision could have significant impact, as the funds are no longer offered protection during bankruptcy proceedings.
The total amount of funds that will potentially be available to creditors is unknown, but with an estimated 6.5 trillion held in IRAs it could be substantial.
While estate planning and the potential for a bankruptcy is not something that most of us think too much about, the recent holding by the Court could make it an important consideration. Without the protection of “retirement funds,” many Americans could have inheritance they believe their heirs would receive turn up in creditor’s hands.