Are Inherited IRAs Protected from Creditors?

inherited IRA

Like most people, you may intend to make the beneficiary of your IRA your spouse or children. However, you may want to change that in response to the Supreme Court ruling that the same credit protection in bankruptcy does not insulate inherited IRAs as traditional or Roth IRAs. If you decide to leave IRA funds to a beneficiary who has financial difficulty and files for bankruptcy, the IRA funds you left could be used to pay creditors. As such, taking the necessary steps to protect your beneficiaries and assets when planning your estate is crucial. If this could concern you or someone you know, please don’t hesitate to contact a determined Montgomery County Estate Planning Attorney who can help navigate your legal options. 

What Are Inherited IRAs?

An inherited Individual Retirement Account (IRA), or Beneficiary IRA, is an account opened when someone inherits an IRA or employer-sponsored retirement account after the original owner’s death. It’s crucial to understand that you can’t make additional contributions as a beneficiary who inherits these accounts. However, you can utilize the funds in the account. Additionally, the funds can remain tax-deferred, and you can withdraw money immediately without any penalties. A designated beneficiary must liquidate the account or otherwise remove all funds from the account by the end of the tenth year following the year of the IRA owner’s death. If the funds remain in the account after ten years, you will face hefty tax implications.

Can They Be Used to Pay Off Debts?

On June 12, 2014, the U.S. Supreme Court unanimously decided that IRAs inherited by anyone other than a spouse are not to be considered retirement funds and, therefore, are not protected from the beneficiary’s creditors in bankruptcy. However, if you name your spouse as your beneficiary, they can “roll over” the assets into their own traditional or Roth IRA or open an inherited IRA to hold the assets. If anyone other than your spouse is your beneficiary, they won’t have the option of “rolling over” the assets and must use an inherited IRA.

Since beneficiaries who are not spouses cannot make additional contributions or delay distributions until retirement, the account is not considered a retirement account. Therefore, nothing prevents a beneficiary from withdrawing funds or clearing out the account. As such, these funds can be claimed by creditors to satisfy any outstanding debts the benedict has during bankruptcy.

How Can I Shield My IRA from Creditors?

If you plan on leaving your children or another loved one an inherited IRA, you should create an IRA trust and name the trust as the beneficiary to shield the funds from creditors. Essentially, by using a trust as the beneficiary of your IRA, you can continue the tax-deferred earnings over the beneficiary’s life expectancy. It will let you control when the beneficiary receives distributions and safeguard your hard-earned savings from the beneficiary’s creditors. Remember that if a trust fund owns the inherited IRA, the funds must be distributed within five years of the inheritance.

With the proper estate planning, you can protect your IRA, which you intend to leave to your loved ones, in case of bankruptcy. At JD Katz, we understand how complex these matters can be, so you should immediately ensure that your beneficiary’s creditors can’t seize your IRA. Contact our legal team today to discuss your concerns and how we can assist you.