Retirement Assets Risk Exposure to Bankruptcy Creditors

Mr. Baby Boomer worked hard his entire life and faithfully maxed out annual contributions to his individual retirement account (IRA). Mr. Boomer was diligent about arranging his affairs. Upon Mrs. Boomer’s passing he confirmed with the financial advisor managing his IRA that his beloved daughter had already been named as contingent beneficiary of his IRA. Mr. Boomer could rest in peace knowing that his daughter would be able to benefit from the money he saved over the years.

Mr. Boomer’s daughter was devastated by the loss of her father but thankful to receive money from her father in the form of an inherited IRA. The inherited IRA would allow the money to continue to grow tax deferred while providing cash in the form of annual required minimum distributions. But Mr. Boomer didn’t know of the severe financial distress his daughter and her husband were in. They had creditors garnishing their wages after obtaining money judgments for debts that they owed.

After careful consideration a bankruptcy was filed (on their own without an attorney) to stop the garnishments and alleviate the crushing weight of the money judgments that they would never be able to satisfy. They listed all of their assets in the paperwork along with the corresponding federal exemptions that would allow them to keep such assets. They had heard that federal law protected IRA’s and retirement accounts from creditors. They were shocked when the bankruptcy trustee said the balance of the inherited IRA would in fact be used to satisfy creditors pursuant to a 2014 U.S. Supreme Court Case. Clarke v Rameker, Trustee, 573 U.S. ___ (2014).

Many people have heard that the law protects IRAs and similar retirement accounts. This protection means that creditors looking to satisfy a judgment cannot touch the balance of these accounts. It also means that a bankruptcy trustee in the bankruptcy process cannot consider those assets available to satisfy creditor’s claims. But the June 12, 2014 U.S. Supreme Court case specifically found that an inherited IRA was not protected under federal exemptions for retirement accounts in bankruptcy. 11 U.S.C.§ 522(b)(3)(C). This means that if Mr. Boomer had filed bankruptcy it would have been protected. But, because his daughter inherited it from him, and then filed bankruptcy claiming federal exemptions – it did not maintain that special treatment.

Anyone planning to pass IRAs or other retirement accounts to their heirs should think carefully about protecting such valuable assets. It is now clear from the June 12, 2014 decision that if someone with an inherited IRA files bankruptcy and claims federal exemptions that they will not be able to keep the value of the inherited IRA. It is important to note the availability of Michigan’s bankruptcy exemptions (versus federal exemptions) and other statutes that exempt assets outside of the bankruptcy process. However, until Michigan courts clarify the position on the protection of an inherited IRA, it is important to be aware of this scenario during the estate planning process. The creation of a trust with spendthrift provisions that will receive the IRA on behalf of the heir would be an option to explore.

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