Inherited IRAs and Creditor Protection

January 6, 2015

Your IRA is protected from creditors if you have to file bankruptcy, but what happens to that IRA if you die and leave it to a child? Many assumed that the inherited IRA retained that creditor protection in a child’s bankruptcy. The United States Supreme Court ruled otherwise in Clark v. Rameker, 134 S. Ct. 2242 (2014).

The Supreme Court ruled that inherited IRAs are not “retirement funds” within the meaning of the United States Bankruptcy Code’s exemptions.  Therefore, when a person files bankruptcy, assets in an inherited IRA are available and must be used to pay creditors. The inherited IRA is treated the same as an outright cash gift to your beneficiary. There is no protection.

One of the reasons the inherited IRA loses creditor protection is that the funds in the inherited IRA can be withdrawn by the beneficiary at any time, without any penalty. Even if a child is not at risk for filing bankruptcy, many IRA owners shudder at the thought of a beneficiary withdrawing most or all of an IRA for fancy cars, expensive vacations or other lavish items.

The average revocable living trust is not typically designed to deal with retirement plan assets. Indeed, making the average revocable living trust the beneficiary of your retirement plan assets can lead to harsh income tax consequences. A trust specifically designed to deal with retirement plan assets, however, can maintain protection from a child’s creditors and prevent lavish spending. Retirement plan trusts can also provide for professional asset management and ensure that retirement assets take the fullest advantage of the opportunity for tax free growth.

There are some drawbacks to retirement plan trusts. Trusts pay income taxes at higher rates than individuals. These trusts also add complexity to your estate plan and are best administered by professionals who can ensure that the administration of the trust complies with all of the relevant IRS rules. Consequently, anyone with significant retirement plan assets should seek the advice of a knowledgeable and experienced estate planner to help determine whether a retirement plan trust is the best option for their situation.

By Michael Olsaver, you may contact him at or 517-423-5404.


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