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Supreme Court unanimously rules that funds in an inherited IRA are not exempt from bankruptcy proceedings

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Heidi Heffron-Clark’s father passed away at the age of 52.  After his death, his wife rolled his IRA into her IRA.  Then in 2001, Heidi’s mother also passed away after she had named Heidi her sole beneficiary for the IRA.  Heidi transferred the IRA into an inherited IRA and began taking monthly distributions.  After Heidi’s marriage to Brandon Clark, the two of them opened a pizza place but owing to the recession the business failed.  The Clarks owed about $700,000 to creditors.  Because the two of them could no longer meet their business or family living expenses they applied for joint bankruptcy.  Brandon and Heidi argued that the inherited IRA, worth around $300,000, was a retirement account and was therefore exempt from bankruptcy proceedings.

William Rameker, the trustee in charge of administering the couple’s bankruptcy estate felt that the inherited IRA, which would have gone a long way toward discharging the debt, was available to creditors.  The bankruptcy court found the inherited IRA available since it no longer represented anyone’s retirement account.  The Clark’s appealed and the district court reversed, holding that the exemption holds true for any account originally set aside for retirement.  The Seventh Circuit Court of Appeals reversed that ruling, holding that the IRA was an IRA in name only and did not constituted retirement funds since the beneficiary was able to withdraw monies from the account.  The Supreme Court agreed to hear the case.

On June 13, the Supreme Court unanimously affirmed the Seventh Circuit’s decision.  According to the Supreme Court, an inherited IRA retains features such as the funds ability to grow tax-free but those funds are not retirement funds because the beneficiaries of the inherited IRA cannot invest additional money in the account, are required to withdraw money even if they are not close to retirement age, and indeed may withdraw all of the balance from the account at any time.

With two-thirds of Baby Boomers standing to receive some inheritance over their lifetime, this situation is likely to rear its head again and again.  One way to protect the IRA, would have been for Heidi’s mom to have left it in a trust rather than directly to her beneficiary.  This would have provided the creditor protections needed in this case.

You can read more on the court case by clicking this link.  Clark v Rameker (US., No. 13-299)

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