Supreme Court Decision Impacts Inherited IRAs

David A. Applebaum, Robert A. Bacine, Marjorie J. Scharpf

In an effort to simplify their estate plans, the vast majority of IRA owners name their spouse and then their adult children as the beneficiaries of their IRAs. The recent U.S. Supreme Court decision, Clark v. Rameker, may cause IRA owners to rethink that strategy. In Clark, the Supreme Court held that an inherited IRA is not protected from creditors as a retirement fund under the U.S. Bankruptcy Code. The Clark decision demonstrates how important it can be to leave assets, including IRAs, to beneficiaries in trust.

Clark had creditor problems and was forced to file bankruptcy. In the course of the bankruptcy, Clark attempted to preserve the IRA he had inherited from his mother by arguing that his inherited IRA was protected under the U.S. Bankruptcy Code as a retirement fund.Justice Sotomayor, writing for the unanimous Supreme Court, rejected Clarks argument. She pointed out that inherited IRAs differ from traditional IRAs in a number of ways including: (1) the owner of an inherited IRA can withdraw funds for any purpose without penalty regardless of age; (2) minimum distributions are required for inherited IRAs regardless of the owners age; and (3) the owner can never add funds to an inherited IRA. While some inherited IRAs may be used by their owners to fund their retirements, this fact alone did not compel the Supreme Court to extend bankruptcy protection to inherited IRAs.

The Clark decision illustrates that IRA owners should review their beneficiary designations carefully and consider naming an IRA Trust as a beneficiary in appropriate situations. An IRA Trust may be the best solution, not only when your named beneficiaries have creditor problems, but also when your beneficiaries are simply too young or too inexperienced to have unrestricted access to the large sums of money that are held in the IRA.

Different types of IRA Trusts can be used to accomplish the IRA owners goals. Naming a Trust as a beneficiary of an IRA can permit the same tax deferral as naming an individual. This is commonly referred to as a stretch IRA. However, before designating a Trust as a beneficiary of your IRA, the Trust should be reviewed by an estate planning attorney to ensure that the Trust has been properly drafted to hold an IRA. Not all Trusts are qualified IRA beneficiaries. A Trust which has not been drafted to be a qualified IRA beneficiary can actually accelerate the distribution of the IRA and accelerate the tax.

So-called conduit or accumulation Trusts can hold IRAs and have been utilized to both defer tax and protect beneficiaries who may have creditor or money management problems. The Supreme Courts decision in Clark v. Rameker has made these estate planning goals more difficult to accomplish. However, if you establish a Trust and sign appropriate beneficiary designations, the distribution of your IRA at death can still be controlled by a trustee and protected from potential beneficiary creditor claims.

Please contact our offices if you or someone you know needs to have a Will, Trust or IRA beneficiary designation reviewed or modified to comply with this important U.S. Supreme Court decision.