By: Jason Palmisano
In 2001, Heidi Heffron-Clark of Wisconsin inherited an individual retirement account (IRA) valued just over $450,000 from her mother. In 2010, Heidi and her husband filed for bankruptcy. The Clarks sought to exclude the inherited IRA from their bankruptcy estate which would block their creditors from obtaining any proceeds from the inherited IRA. At the time of the bankruptcy filing, the inherited IRA was worth approximately $300,000. In a unanimous decision, the Supreme Court of the United States held the inherited IRA was included in their bankruptcy estate and was not protected from the Clark”s bankruptcy creditors. The Supreme Court reasoned an inherited IRA is distinct from an individual’s own IRA, and thus not exempt from creditors in bankruptcy, for 3 reasons:
1. Unlike an individual’s own IRA, the holder of an inherited IRA may never add additional funds to the account;
2. The holder of an inherited IRA is required to withdraw money from the account, no matter how far the holder may be from retirement; and
3. The holder of an inherited IRA may withdraw the entire balance at any time and use it for any purpose – without penalty.
The decision stated, “[f]or if an individual is allowed to exempt an inherited IRA from her bankruptcy estate, nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete.” Fair enough. But keep in mind this decision does not mean your own individual retirement account (which you have personally funded over your lifetime) is subject to the individual’s creditors; only that an IRA you inherit from a loved one is subject to your creditors if you ever file for bankruptcy. Plan accordingly!
