How to Protect Inherited IRAs After the Clark v. Rameker Decision

In the case Clark v. Rameker the United States Supreme Court handed down a landmark, unanimous decision that held that inherited IRAs are not “retirement funds.”

This ruling is important to you and your family because it means you need to take action to insure your retirement funds are protected when they pass to the next generation and, perhaps, even to your spouse.  
In this case, Ruth Heffron created an IRA, naming her daughter, Heidi Heffron-Clark, as beneficiary. After Ruth died, Heidi transferred the IRA assets into an “Inherited IRA”
Nine years later, Heidi and her husband filed bankruptcy and sought to protect the Inherited IRA from their creditors by arguing the inherited IRA assets were protected retirement funds. Both the bankruptcy trustee and the judgment creditors objected. 
The Supreme Court ruled that funds held within an inherited IRA are not “retirement funds.” As a result, they have no protection as retirement funds and can be seized to pay off debt. The Court reached its conclusion using three elements, which differentiate an inherited IRA from a participant-owned IRA:

  1. The beneficiary of an inherited IRA cannot make additional contributions to the account, while an IRA owner can.
  2. The beneficiary of an inherited IRA must take required minimum distributions from the account regardless of how far away the beneficiary is from actually retiring, while an IRA owner can defer distributions at least until age 70 ½.
  3. The beneficiary of an inherited IRA can withdraw all of the funds at any time and for any purpose without a penalty, while an IRA owner must generally wait until age 59 1/2 to take penalty-free distributions. 
    This logic is easily extended to all inherited defined contribution retirement plan accounts, so inherited 401(k) and 403(b) accounts are also affected.

What Can Be Done to Protect Inherited IRAs?
In light of the Clark decision, everyone must reconsider outright beneficiary designations. By far the best option for protecting an inherited IRA is to create a Standalone Retirement Trust. If properly drafted, this trust offers the following advantages:

  • Protects the inherited IRA from beneficiaries’ creditors, predators and lawsuits
  • Insures that the inherited IRA remains in the family bloodline and out of the hands of a beneficiary’s spouse (or soon-to-be ex-spouse)
  • Allows for experienced investment management and oversight of the IRA assets by a professional trustee
  • Prevents the beneficiary from gambling away the inherited IRA or spending it all on exotic vacations, expensive jewelry, designer shoes, and fast cars
  • Enables proper planning for a special needs beneficiary
  • Permits minor beneficiaries such as grandchildren to be immediate beneficiaries of the inherited IRA without the need for a court-supervised guardianship
  • Facilitates generation-skipping transfer tax planning to insure that estate taxes are minimized or even eliminated at each generation

A handful of states – including Alaska, Arizona, Florida, Idaho, Missouri, North Carolina, Ohio and Texas – have either passed laws or had favorable court decisions that specifically protect inherited IRAs under state bankruptcy statutes. If the IRA beneficiary happens to live in one of these states, they may be able to protect their inherited retirement funds by claiming the state law exemption instead of the federal law exemption.
Caution should be used in relying on state law to protect a beneficiary’s inherited IRA. In general, people are more mobile than ever and your beneficiary may need to move from state to state to find work, pursue educational goals, or be closer to family members. In addition, federal bankruptcy laws now require a debtor to reside in a state for at least 730 days to use state bankruptcy exemptions. Therefore, long-term planning should not rely on a specific state law but instead should take a broad approach.

If you have retirement funds that you would like to pass on to your spouse, children or grandchildren, please contact our office now at 518-459-2100 (Capital Region), 212-661-2480 (NYC), 315-732-3155 (Utica Area), toll-free at 866-951-PLAN or contact us online. We will show you how to protect your assets from your beneficiaries’ bankruptcy creditors, divorcing spouses, frivolous lawsuits, medical crises, and bad decisions. 
This is certainly not one-size-fits-all planning and can only be done on an individual, case by case basis. By working together with your other trusted advisors, the attorneys at the Pierro Law Group are here to answer your questions about protecting your assets through proactive Estate and Long-Term Care Planning. We look forward to working with you!