On June 12, 2014, in the case of Clark v. Rameker, the U.S. Supreme Court held that inherited IRAs receive no protection from creditors in bankruptcy. In 2000, Ruth Heffron established a Traditional IRA naming her daugher, Heidi Heffron Clark, as the sole beneficiary of the account. Ruth died a year later. At death, the IRA had $450,000 in it. Heidi didn't cash it in. Instead, she decided to take monthly distributions from the IRA. In 2010, Heidi and her husband fell on hard times and filed Chapter 7 bankruptcy in Wisconsin. The IRA had shrunk in value to $300,000 but Heidi claimed it was an exempt retirement fund under Section 522(b)(3)(C) of the Bankruptcy Code. The bankruptcy trustee claimed that the inherited IRA was not a retirement fund under the Bankruptcy Code and Wisconsin has no exemption for inherited IRAs.
The Supreme Court held that because an inherited IRA does not contain the debtor's retirement funds, an in, an inherited IRA does not qualify for the retirement fund exemption under Section 522(b)(3)(C). Unlike a traditional IRA, an inherited IRA is not set aside for the day an individual stops working. The holder of an inherited IRA cannot invest additional funds in the account. The entire purpose of Traditional and Roth IRAs is to provide tax incentives for workers to contribute regularly to their retirement savings. Holders of inherited IRAs are required to take annual distributions from the accounts no matter how many years the holder may be from retirement. An inherited IRA naming the estate as beneficiary must be withdrawn within 5 years so it serves no retirement purpose. Because the tax laws require reduction of the account over time, it is not a retirement fund for the beneficiary. Finally, the holder of an inherited IRA may withdraw the entire balance of the account at any time without the payment of the 10 percent penalty prior to the age of 59½. Thus, it is fully available to the inherited IRA beneficiary without penalty.
Would this seminal case apply in Connecticut? Under Connecticut law, any asset or interest of debtor in, or payments received by a debtor from, a plan or arrangement described in the Connecticut statutes is exempt property. Under Connecticut law, individual retirement accounts are exempt from claims of creditors of not only the participant but also creditors of the beneficiary. A Connecticut resident who is a beneficiary of an inherited IRA would just need to claim the State exemptions allowed under Section 522(b)(3)(A) of the Bankruptcy Code to exempt the inherited IRA in bankruptcy.
Limits on creditor exemptions for retirement plans in Connecticut do exist, however. The rights of spouses and children under a Qualified Domestic Relations Order (QDRO) override Connecticut's exemption. Nothing impairs the rights of the State of Connecticut to recover the costs of incarceration. Funds in an inherited IRA do not impair the rights of a victim of a crime to proceed against that IRA.
We are only aware of 6 states that exempt IRAs from creditors of beneficiaries --- Alaska, Arizona, Connecticut, Florida, Missouri or Texas. Can you still protect your IRA for your child if the child does not live in one of those states? The answer is yes. You could leave the IRA in a trust for the benefit of your child with a Trustee who is not your child. Because the child will not own the inherited IRA, it will not be part of his or her bankruptcy estate.
