When is an individual retirement account not a retirement account? When the Supreme Court says so. In a unanimous decision in June, the Supreme Court ruled that an inherited IRA is no longer a retirement account—noting that a beneficiary can withdraw any amount from the account without penalty whenever he or she wishes—and so isn’t protected from creditors under federal bankruptcy law.
Because of the recent unanimous high court decision, experts and families are taking steps to protect IRA assets for beneficiaries in the event those heirs declare bankruptcy.
A recent Wall Street Journalarticle, "Court Ruling Sparks Rush to Shield IRAs," finds that many advisers are urging clients to create a trust as the IRA’s beneficiary, or to set up an IRA as a trust account while the owner is still alive. Either way, the original owner has access to the money before he or she dies. Depending on the type and terms, trusts can shield assets (including an IRA) against creditors.
According to the original article, the challenge is identifying and employing the right kind of trust—this can be really tough as these issues are complex. The type of trust you should use will depend on a bunch of factors, such as the number of beneficiaries, the tax goals, and asset-protection goals.
But what if I already own an inherited IRA?
Based on where you live and how long you have been living there, the assets might yet fall under bankruptcy protection. Alaska, Arizona, Florida, Missouri, North Carolina, Ohio, South Carolina, and Texas all have laws that give this protection in some circumstances, even after the Supreme Court's decision.
One more thing: the Supreme Court did not directly address surviving spouses who inherit an IRA. Their status is far from certain, but some experts suggest that they roll over an inherited IRA into one under their own name.
Talk with your estate planning attorney and see what the new Supreme Court decision on IRAs means for your assets and your plans.
Reference: Wall Street Journal (Oct. 12, 2014) "Court Ruling Sparks Rush to Shield IRAs"