Who would have thought that inherited IRAs are not retirement funds? However, this is the case when it comes to bankruptcy proceedings. According to the U.S. Supreme Court, inherited IRAs are not exempt by U.S. Bankruptcy Code as retirement funds. The details of the case can be found here, but ultimately, Justice Sonia Sotomayor cited legal characteristics of inherited IRAs that cause them to not be considered retirement funds. The three characteristics are:
- the holder of an inherited IRA may not deposit additional dollars into the account
- the holder of an inherited IRA must take distributions from the account, regardless of age
- the holder of an inherited IRA may withdraw the entire balance at any time without a penalty (unlike a traditional or Roth IRA)
As a result, inherited IRAs are not the same as other retirement funds for the purpose of a bankruptcy.
So can you do anything to protect inherited IRA assets? Absolutely! According to George Hinnant, Attorney with Obenshain, Hinnant & Associates, LLC, one should consider an IRA Trust. The IRA Trust could block creditors of the beneficiary from reaching the funds.
Additional benefits of an IRA Trust include stretching out Required Minimum Distributions (RMD), preventing a surviving spouse from diverting IRA assets to beneficiaries not named by the owner, spendthrift provisions, Medicaid protection, and asset protection for the beneficiary in case of a divorce.