You Won't Like What the Supreme Court Just Did to Your IRA

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Millions of people use individual retirement accounts to save for retirement. But as IRAs have grown both in popularity and in size, they've also started to become a target for creditors looking for money to repay outstanding loans. Now the Supreme Court, in a unanimous ruling released Thursday, has opened the door for what could be a major change in collections practices.

The nation's highest court decided a case that dealt with how bankruptcy law treats IRAs inherited from other family members. In the case, a married couple declared bankruptcy, owing about $700,000 to creditors. The couple sought to have an IRA that the wife had inherited from her mother excluded from the assets available to creditors, arguing that bankruptcy law provides creditor protection for retirement accounts.

Inherited IRAs and Bankruptcy Protection

Bankruptcy law protects a person's own retirement accounts, with 401(k) plan accounts having long been protected from creditors under laws governing employer-sponsored retirement plans. Amendments from about a decade ago made rollover IRAs from 401(k) and similar plans exempt from bankruptcy creditors, as well as an additional amount of about $1.24 million from IRAs into which you made direct contributions.

The Supreme Court this week drew distinctions between one's own retirement accounts and those inherited.

The Supreme Court this week drew distinctions between one's own retirement accounts and those inherited. In protecting a worker's retirement accounts from creditors, the bankruptcy laws support the important financial consideration of ensuring financial security throughout one's lifetime -- the very thing retirement accounts were designed to provide.

With inherited IRAs, though, the retirement-centered aspects of the account largely go away. Beneficiaries of inherited IRAs are required to take distributions either within five years of inheriting the account or on a schedule determined by life expectancy and required minimum distribution amounts over the course of their lifetimes. Moreover, heirs of inherited IRAs have the ability to take money out at any time without facing penalties, even if they haven't yet reached age 59½. That's much different from how one's own IRAs are treated, with a 10 percent penalty typically applying to early withdrawals.

Of course, many heirs of inherited IRAs would like to use those accounts primarily for retirement. But if anyone other than a surviving spouse inherits an IRA, they're not allowed to roll over assets into their own IRAs, and the Supreme Court saw the different nature and rules of those accounts as a way to open the door to creditors claiming assets from those inherited IRA accounts.

What It Means to You

With 45 million households in possession of retirement accounts adding up to $5.7 trillion as of a year ago, the amount of money potentially affected by the Supreme Court decision is huge. If you intend your children, grandchildren or heirs other than your spouse to receive IRA funds after you die, you'll need to consider whether their creditors could end up taking the money and thwarting your intentions.

Those who plan to leave behind substantial amounts in IRAs can consider making sophisticated changes to their estate planning, establishing trusts to receive inherited IRA money rather than leaving it outright to your heirs. But using trusts carries pitfalls of its own, and the wrong terms can reduce or eliminate the ability to stretch out IRA distributions and preserve tax benefits as long as possible.

Given the challenges that most people face in saving enough for retirement to provide for their own needs -- let alone leaving something behind for heirs -- the Supreme Court's decision might seem like it only affects the extremely rich. But for those who had hoped to preserve a pool of savings for their family after their death, making inherited IRAs subject to creditors' claims in bankruptcy is a setback for their estate-planning goals.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.

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66 Comments

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anamaryp

It makes sense to me! It would be great to inherit some money to help pay off your debts, if you have any! Why does this writer make it seem like the companies are stealing the money? The money is due to them for things or services that were bought. You buy, you pay...otherwise isn't THAT stealing??

June 29 2014 at 12:37 PM Report abuse rate up rate down Reply
ohringen

Good article. However, it does not state what the average dollar amount is for the so called 45 million households, that hold IRA's. I personally know several people that have IRA's that have no more than $7,000.00 -$10,000.00 in their accounts, at any given time, because, they keep taking money out to buy things, ( and paying a 10% penalty to do so) I don't see any great wealth being passed on to anyone's heirs, except the rich, because the real truth is that average Americans are just trying to keep their heads above water.

June 27 2014 at 7:42 AM Report abuse rate up rate down Reply
kirby555

some people don't know the the makeup of the nine members of the court. To make a statement Tea Party, Koch Brothers, is stupid.

June 17 2014 at 8:58 AM Report abuse rate up rate down Reply
sam54ct

Nice title, to bad it's about "inherited" IRA's, given personal IRA's, 401k plans, pensions etc., are still off limits to creditors. Pay your bills, no problem.

June 16 2014 at 9:54 AM Report abuse +2 rate up rate down Reply
ectullis

Someone has to pay for BHOzocare

June 15 2014 at 10:30 PM Report abuse rate up rate down Reply
2 replies to ectullis's comment
robantm

Well that's a stupid comment. Shouldet flakes have to pay their debts?

June 15 2014 at 11:40 PM Report abuse +1 rate up rate down Reply
robantm

Well that's a stupid comment. Shouldet flakes have to pay their debts?

June 15 2014 at 11:40 PM Report abuse +1 rate up rate down Reply
jpark377

This is all about making sure the attorneys get paid. Plain and simple. This is just the first salvo fired at IRA's by the politicians, who have considered them sacred up to now. The media refuses to report that Barry wants to force RMD's on Roth IRA's (it's in his new budget), in order to force the money out of the tax-free Roth IRA into taxable accounts. I'll use an Obama term to describe this proposed change to Roth IRA's: it's NOT FAIR! The greedy politicians are seeing all that cash accumulate in Roth IRA's, and they can't wait to get their hands on it through changing the rules. A cap on the cash allowed in a Roth IRA is just another great idea by this feckless President.

June 15 2014 at 9:16 PM Report abuse +2 rate up rate down Reply
dquandle

I don't like what the supreme court does about anything. They are the poster children for corporate prostitutes. Owned and operated by the parasite class.

June 15 2014 at 8:30 PM Report abuse +2 rate up rate down Reply
eweneeeek

How is this wrong? This writer seems to believe that a creditor is not entitled to collect his debt!

June 15 2014 at 8:23 PM Report abuse rate up rate down Reply
bryan

Just die in debt the american way

June 15 2014 at 5:14 PM Report abuse rate up rate down Reply
hsstempe

NOW WE HAVE THE SUPREME COURT STEALING FROM THE DEAD!
if ever there were south end of north bound horses our government and court systems are THE PRIME DISPLAY and have no qualms if what someone works their entire life for to provide an assset base for future generations for college and living. Today the Pope proclaims the world economy is on the verge of total economic collapse. No shi* sherlock. The ultimate weapon is bankruptcy and the chinese will find it out. Stock market out of control, middle east ready to blow up yet, still and AGAIN, O'DUMB ASS with his crooked Geitner printing money faster than presses can run, stealing from the dead isn't surprising given the mentality of these worthlesss idiots. How about meet my mommies! Things have and are going to hell faster than the faithless morons in this contry to include the dumb asses who laid this ruling out. Someone kick these fools so damn hard their dead ancestors feel it! THIEVES PURE AND SIMPLE and to appoint these morons to a lifetime appoint, pure and simple DUM B AS A PILE OF BUFFALO CRAP IN A BOX!

June 15 2014 at 4:15 PM Report abuse +1 rate up rate down Reply
2 replies to hsstempe's comment
ktv813

How is this about Obama? He appointed only 2 members of this 9 member court. Maybe you're the dumbass.

Another point is that you are ok with people filing bankruptcy and keeping their inheritance. What if the people who inherited IRA's owe me and they file bankruptcy because they made a stupid deal and now my kids don't get to inherit my money? Oh, you never thought about that. Well, then, that settles it, it is you who is the dumbass.

June 15 2014 at 4:32 PM Report abuse +1 rate up rate down Reply
robantm

So, by your reasoning it's ok for deadbeats to steal from the living?

June 15 2014 at 11:48 PM Report abuse rate up rate down Reply