Inherited IRA’s and Creditors

The normally staid world of Individual Retirement Account planning has been shocked by the recent United States Supreme Court case of Clark v. Rameker.  Nearly every day a new article or seminar advertisement related to this case pops up on my e-mail.

Under the Federal Bankruptcy Code “retirement funds” (e.g., Individual Retirement Accounts and 401(k) funds) are not includable in the debtor’s bankruptcy estate.  However, that general exemption has been trimmed back by the Rameker case. 

When a person dies, the two most frequent dispositions of his Individual Retirement Account are either the rolling over of the account by a surviving spouse, or the “inheritance” of the account by the named beneficiary on the account.  It is the “inherited account” that was the subject of the Court’s attention in Rameker.  The owner of an “inherited” account must begin taking out distributions no matter what his age and he is not subject to the 10% penalty for an early withdrawal.  Contrast this with the treatment received by the initial owner, who is subject to a 10% penalty in the event that he withdraws funds before the age of 59 1/2 and who must begin taking the required minimum distributions only upon reaching age 70 1/2.  In the hands of the original owner the IRA’s requirements make it more likely that the fund will be kept aside and used at an advanced age.  In the hands of the owner of an inherited IRA there is far less incentive to hold the funds for that person’s retirement and there are forced distributions that run counter to the goal of saving for retirement.

The Court seized upon these differences to determine that an inherited IRA is not in fact a “retirement fund” for purposes of the Bankruptcy Code.  With that conclusion reached, it becomes clear that an “inherited IRA” is to be included in a debtor’s bankruptcy estate.  The Rameker case itself provides a good illustration of the effect.  In that case the debtor had inherited a $300,000 IRA from her mother, and claimed those assets were not reachable by creditors in bankruptcy.  The Supreme Court’s decision meant that the $300,000 was in fact included in the bankruptcy estate.  One can imagine a scenario in which the Rameker decision would result in a debtor not even qualifying for bankruptcy.  It is not hard to picture a debtor whose assets are less than their liabilities if an inherited IRA is not included (bankruptcy allowed), but whose assets are greater than his liabilities if an inherited IRA is included (bankruptcy dismissed).  What percentage of potential filers this will affect is hard to guess.

The open question, and perhaps the more important one from our perspective, is whether such an inherited IRA is exempt from creditors under Pennsylvania law.  Generally speaking, a retirement fund that is not the result of annual contributions in excess of $15,000.00 is not attachable by a debtor’s creditor in a Pennsylvania state court judgment proceeding.  This preferential treatment is available under a specific Pennsylvania law that applies to a “retirement or annuity fund” under specified sections of the Internal Revenue Code.  It also applies to “transfers” between such funds.  The United States Supreme Court has spoken with regard to the status of an inherited IRA under federal bankruptcy laws.  It would be surprising if during the coming years, the Pennsylvania Supreme Court does not rule on whether an inherited IRA is exempt from a Pennsylvania state judgment attachment. 

– Rod Fluck


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