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Bankruptcy, Creditors, and Individual Retirement Accounts

When a person files for bankruptcy, certain of his assets may be exempt from the bankruptcy estate available to creditors.  This is the case with traditional and Roth Individual Retirement Accounts (IRAs).  Under the US Bankruptcy Code, these funds remain the debtor’s personal property so that he will be able to fund his basic needs during his retirement years. Creditors have no right to these funds.

A recent Supreme Court ruling made clear, however, that IRAs are not exempt under certain circumstances.  In the case of Clark et ux., Petitioners v. Rameker, Trustee, et al., Mrs. Heffron-Clark and her husband filed for bankruptcy and claimed that the IRA she had inherited from Mrs. Heffron-Clark’s mother was exempt from the bankruptcy estate citing the “retirement funds” exemption. The Supreme Court ruled against the Clarks, stating that inherited IRAs are not constrained in the same manner as personal IRAs and, therefore, are not eligible for the “retirement funds” exemption.  Specifically, unlike a personal IRA that only permits an individual to withdraw such funds without penalty starting at  age 59 1/2, funds from inherited IRAs may be withdrawn by the beneficiaries at any time without penalty, and may be used for any purpose.  Therefore, the exemption is not applicable to inherited IRAs.

However, if Mrs. Heffron-Clark’s mother, Ruth Heffron, had established an IRA Beneficiary Trust rather than bequeathing the IRA outfight to her daughter, then things would have been different.

Specifically, by establishing the IRA Beneficiary Trust, upon Ruth Heffron’s death

– the IRA funds would have remained the property of the Trust; the IRA would not have become Mrs. Heffron-Clark’s outright property.

– as long as the money remained  in Trust, it would have been protected from creditors, spouses, divorces, lawsuits, loss of government benefits such as Medicaid, and estate taxes.

– Mrs. Heffron-Clark would have been able to “stretch out” withdrawals from the Trust under IRS rules permitting required minimum distributions (RMDs) for a set number of years.  (This would have left more funds in the Trust available for appreciation over time.)

– only those RMD funds that her daughter withdrew would have been available to creditors.

Getting Legal Help:

Experienced Estate Planning Attorney, Elga A. Goodman, can help you navigate the world of Trusts and develop an estate plan that best meets your needs and those of your loved ones.  Contact us today at 973-841-5111.

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