When people save enough to fund their own retirement, there is a net benefit to society. That is why the tax code includes incentives to encourage people to sock money away in their retirement accounts, like an IRA.
And on the flip side of the coin, those retirement accounts are generally unreachable by your creditors, even if you have to file for bankruptcy. Apparently, Congress decided that the “fresh start” that people are looking for in bankruptcy could be a net drain on society if people are stripped of their retirement savings.
Recently, however, the U.S. Supreme Court eroded some of the protection that IRA’s receive in bankruptcy. Specifically, the high court ruled that an inherited IRA is not a “retirement account” as that term is defined in the Bankruptcy Code. As a result, funds in an inherited IRA are not protected from creditors in bankruptcy.
This is a significant decision.
A vast amount of American wealth is sitting in IRA accounts. Most people with an IRA have designated a beneficiary to receive those funds upon their death. If the person who inherits the IRA is not the your spouse, then the inherited IRA must be liquidated within 5 years, or the new owner may elect to take payments over time. Either way, the money must be drawn down, and no new money may be added.
If your estate plan includes disposition of an IRA to your children or grandchildren, consider what would happen if one of them filed for bankruptcy. All of the money that you scrimped and saved over the years could be gone in a flash—particularly if you know (or suspect) that your heir apparent is prone to making bad money decisions.
As we always tell people, estate planning is a process, not a one-time event. It includes wills and trusts, to be sure, but it also involves reviewing and understanding how you own all of your assets, and how the law will treat those assets after you’re gone. Make a point to keep track of new developments and changes in the law (perhaps by signing up for our monthly e-newlsetter?) to be sure that when time comes, your estate plan will work the way you intended it to.