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Sometimes an IRA Is Not a Retirement Account: Here's Why

| July 01, 2016
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Sometimes an IRA Is not a retirement accountIRAs and Roth IRAs receive what is known as a “retirement funds” exemption under Section 522 of the Bankruptcy Code.

This exempts tax-exempt retirement funds from a bankruptcy estate.

Except when they don’t. Here’s why.

Clark v. Rameker, Trustee
In the recent court case Clark v. Rameker, Trustee, the Supreme Court found on June 14, 2014, that an inherited IRA does not have the same creditor protection as an IRA that was originally saved for the purpose of retirement.

While the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), which was signed into law in April 2005, was meant to make bankruptcy filings less appealing — it contained a protection for retirement funds. This protection allows IRAs and Roth IRAs a total of $1 million exemption, adjusted for inflation (today that amount is $1,245,475).

Employer-sponsored plans received an unlimited exemption.

So this presents a challenge to the old way of doing things.

It isn’t unheard of to see an inherited IRA. No, they aren’t the norm, but spouse-inherited IRAs do exist. Only now maybe they shouldn’t. Here’s the issue:

  • By not taking the extra step of rolling over an inherited IRA to their own IRA, a spouse now apparently may not have the same creditor protection for that inherited IRA. A spouse is allowed to combine an inherited IRA from a deceased spouse with their own IRA, unlike other inherited relationships to IRA owners.
  • For non-spousal IRA beneficiaries, it may now be preferable to inherit these retirement funds via a trust. Mind you, the law surrounding this approach is tricky and requires the use of special language since it must comply not only with trust rules, but also with IRA and IRS rules specific to retirement accounts. Crafting this language requires the expertise of an attorney who specializes in such matters.
  • As for the unlimited protection afforded by a company-sponsored retirement plan, it would seem that you would have better protection as a beneficiary; however, that is not necessarily the case.
  • Unless the plan document says so, a non-spouse beneficiary is typically not entitled to inherit the asset as a 401k or 403b and is then subject to a rollover to an inherited IRA, which presents the exact same challenges.
  • Be careful about appointing a general trust as beneficiary, and seek the advice and counsel of professionals when doing any sort of advanced planning.

Now might be a good time to update your beneficiaries and review your estate plan.

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