For many years, it has been the law of the land that retirement plan accounts, including IRA’s, are exempt from the claims of creditors, including creditors in bankruptcy.
The exemption has been available not only to the original owner of the account, but also to children or grandchildren who inherit the account.
This offered a useful tool to benefit offspring who might be struggling financially, especially in these times. Recently, the 7th Circuit Court of Appeals pulled back the exemption.
In the case of In re Clark, a mother named her daughter as the beneficiary of an IRA. The mother died when the IRA was worth about $300,000. The daughter kept the IRA as an inherited IRA. She took required minimum distributions for a few years. Then the daughter and her husband filed for bankruptcy.
The creditors of the couple argued that the IRA should not be protected from the couple’s creditors. The court agreed. It concluded that when an IRA is transferred to a beneficiary it is no longer a true retirement plan account. Rather it is a source for current spending. As a result, the creditors, not the daughter, received the balance of the IRA.
Could the mother have done something to prevent this result? The answer is yes.
Rather than naming the daughter as the beneficiary of the IRA, the mother could have named an IRA trust as the beneficiary of the IRA and then named the daughter as the beneficiary of the IRA trust.
An IRA trust would have protected the IRA from the daughter’s creditors. She then could have received the entire account.
If you wish to protect your retirement plan accounts from creditors of children and grandchildren, please contact FOS to discuss the advantages of an IRA trust.
Putting an IRA trust in place is much less expensive than losing a retirement plan account to creditors.