The United States Supreme Court ruling in Clark v.
Rameker could have an impact on what are sometimes an
individual's most significant legacy assets: individual
retirement accounts, or "IRAs." A participant's IRA
is generally afforded protection in bankruptcy proceedings. The
Clark ruling on June 12, 2014, however, clearly provides
that this bankruptcy protection does not extend to the IRA
beneficiary following the participant's death, unless the
beneficiary is a surviving spouse who elects to
"roll-over" the IRA.
Upon the death of an IRA participant, the remaining IRA balance is
distributed to the beneficiaries designated by the participant.
With respect to a beneficiary other than a spouse, the beneficiary
is deemed to receive an inherited IRA. A benefit of an
inherited IRA is that the beneficiary may withdraw funds therefrom
prior to age 59½ without penalty. However, spouses who are
the designated beneficiary have two options regarding the IRA; they
may simply do nothing, in which case they will be deemed to have
received an inherited IRA, or they may elect to
"roll-over" the participant's IRA to their own IRA.
Following a roll-over, all funds held in the surviving spouse's
IRA (including those rolled over) will be administered as part of
the surviving spouse's IRA and subject to the regular IRA rules
(e.g., early withdrawal penalty). In light of
Clark, IRA participants should carefully consider their
beneficiary designations if a potential beneficiary is, is expected
to be, or perhaps at some point in the future may be in financial
distress.
Prior to Clark, it was unclear whether funds in an
inherited IRA were protected in bankruptcy proceedings. The Fifth
Circuit Court of Appeals, as well as a number of bankruptcy courts
across the country, had held such funds were protected while the
Seventh Circuit Court of Appeals declined to extend similar
protection. In Clark, the Supreme Court held inherited IRA
funds were not afforded any bankruptcy protection.
The Clark opinion, however, indicates the funds in a
surviving spouse's IRA which are attributable to a roll-over
remain entitled to such protection.
The Supreme Court's Clark decision could have a
substantial impact on selecting the appropriate designated
beneficiaries of an IRA. Since the IRA will be not be afforded
protection in a bankruptcy proceeding of a non-spouse beneficiary,
a participant who is concerned about the potential financial
stability of the intended beneficiary should consider designating a
trust for the benefit of the intended beneficiary, rather than the
beneficiary individually. While the rules for ensuring there is no
income tax difference between naming the beneficiary directly
versus a trust are complex, the bankruptcy protection afforded by
this approach could be significant. Moreover, with respect to a
beneficiary who is a spouse, the Clark decision is another
factor to be considered in deciding whether to take the IRA as an
inherited IRA versus a rollover to their own IRA.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.