If you ever follow court case decisions, you may be aware that in a variety of cases in different state jurisdictions, some states have ruled that inherited IRAs are protected in bankruptcy and some have ruled that they are not.
The issue was finally brought to the Supreme Court. On June 12, 2014, in a landmark Supreme Court decision, in the case of Clark vs. Rameker, the Court ruled 9 to 0 that inherited IRA assets are not protected in bankruptcy. So, the federal law no longer protects your inherited IRA assets.
Now, you may be thinking, "I thought that there was bankruptcy protection for my IRA assets."
Well, in this case, the Supreme Court cited three reasons why your inherited IRA assets are not protected under bankruptcy.
One big question the Court needed to answer was whether or not your inherited IRA accounts are really retirement accounts. The Supreme Court ruled that your inherited IRA assets are not retirement accounts because they do not have the same characteristics as a retirement account.
Why did they do this? The Court ruled that your inherited IRA accounts are someone else's retirement accounts that transform into something else at the death of the original owner.
The Court took the position that if you are a non-spouse beneficiary, you cannot add assets to the inherited IRA account, unlike a regular retirement account.
The second point the Court established was if you own an inherited IRA account, you must start taking distributions from your inherited IRA after the death of the original owner, and either take the money out within five years or over the course of your lifetime on an annual basis.
This happens regardless of your age, and you may be well below retirement age when you start taking the money out. So, the funds are not reserved for your retirement years.
The third point made by the Court was that you can withdraw your inherited IRA assets without paying a tax penalty at any time and for any purpose, which is different from how your own IRA account is treated.
For instance, you could settle your bankruptcy case today. Tomorrow, you could buy a sports car or a vacation home, or you could spend your money on anything you want using your inherited IRA assets with no tax penalty. Does that sound like a retirement account to you?
The Court made the point that "Allowing debtors to protect funds held in traditional and Roth IRAs comports with this purpose by helping to insure that debtors will be able to meet their basic needs during their retirement years." 1
In a regular IRA or Roth IRA account that you own, you must wait until you reach age 59 1/2 before you can withdraw the assets penalty free.