Last month, the U.S. Supreme Court ruled that “inherited IRAs” are not protected against bankruptcy in the case Clark v. Rameker. It has long been held that retirement accounts like IRAs and 401(k)s are shielded from creditors during bankruptcy, with the intent of protecting a person’s retirement. The Court determined “inherited IRA” characteristics are different than regular retirement accounts you set up on your own behalf. Owners of inherited IRAs received them as a bequest and are not allowed to add to the account, plus there are no penalties for withdrawals, unlike other retirement accounts.
The ruling provides another good reason for surviving spouse beneficiaries to elect a “rollover IRA” instead of an “inherited IRA”. Surviving spouses are different than most beneficiaries because they are allowed to choose between these two options. A surviving spouse who elects a rollover to his/her own IRA will be able to defer required minimum distributions (and taxes) until the age of 70 ½. The new ruling means this kind of account will also be protected against bankruptcy.
However, a spouse who selects the “inherited IRA” will have access to funds sooner without a penalty, which may be important for younger survivors under the age of 59 ½. But, younger survivors will now need to weigh this benefit with the potential threat from creditors.
Everyone’s situation is different and the rules governing retirement accounts are complex. So, seek professional advice before making any major moves.