On June 12, 2014 the United States Supreme Court issued its opinion in Clark v. Rameker, 13-299, ruling that inherited IRA accounts are available to creditors in bankruptcy. At issue was a Bankruptcy Code provision that exempts from a debtor’s bankruptcy estate “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” The Supreme Court determined that inherited IRAs do not constitute “retirement funds” because the holder of an inherited IRA (i) may never invest additional money into the account; (ii) is required to withdraw money from the account regardless of how far he or she is from retirement; and (iii) may withdraw the entire balance of the account at any time, and use it for any purpose, without penalty. Therefore, inherited IRAs are not covered by the Bankruptcy Code exemption even though they are exempt from current income taxation under the enumerated Internal Revenue Code provisions.
This case settles a split in the circuits. Clark was an appeal from a 7th Circuit decision which had similarly ruled that inherited IRAs were not exempt from a debtor’s bankruptcy estate. The 5th Circuit (In re Chilton, 674 F.3d 486 (5th Cir. 2012)) and the 8th Circuit (In re Nessa, 426 B.R. 312 (8th Cir. BAP 2010)) had previously taken the opposite position. Both of those circuits held that inherited IRAs were exempt from a debtor’s bankruptcy estate as long as they were originally established as retirement accounts. In upholding the 7th Circuit’s decision, the Supreme Court evaluated the balance Congress established between the interests of creditors and debtors. Congress permitted an exemption for funds that a debtor would use to meet essential needs in retirement. However, the Court determined that exempting inherited IRAs from a bankruptcy estate would not further this goal.
This ruling will have a significant impact on an individual’s wealth preservation strategy. For many people, retirement accounts such as traditional IRAs, Roth IRAs and IRA Rollovers represent a substantial portion of their assets. Accordingly, protecting these accounts from the creditors of their beneficiaries is critical. After Clark, alternative strategies should be explored in order to provide creditor protection for a non-spouse beneficiary of a retirement account. Naming a trust as the beneficiary of the retirement account instead of an individual can supply such creditor protection.
Financial advisors should alert clients that it is now more important than ever to use trusts in conjunction with retirement accounts. Such trusts must be drafted carefully in order to preserve the income tax-favored treatment of an inherited IRA.
Creditors also should take this ruling into account when reviewing a debtor’s bankruptcy petition. Currently, Schedule B—Personal Property does not separately identify inherited IRAs. Creditors should carefully scrutinize IRA accounts listed on a debtor’s bankruptcy petition to ensure an exemption is not being claimed for inherited IRAs.
 The Clark decision applies to retirement accounts inherited by non-spouses. A spouse-beneficiary of a retirement account may, through a spousal rollover, continue to hold the account as a retirement fund exempt from his or her bankruptcy estate.