IRAs and Asset Protection

The recent Supreme Court decision limiting the protection of inherited IRAs in bankruptcy may be broader than initially thought. IRAs have been protected in bankruptcy since the law was changed in 2005. But a court ruled that an inherited IRA is not a “retirement account” and isn’t protected under the provision. The Supreme Court recently agreed. This post argues that the Supreme Court’s decision could apply to more than inherited IRAs. It could be that spousal rolled over inherited IRAs and even ordinary rollover IRAs aren’t protected in bankruptcy. We won’t know for sure until the Supreme Court rules in cases involving those accounts or Congress revises the bankruptcy code. Until then, people with sizeable IRAs and concerns about asset protection for their beneficiaries might want to consider naming trusts as IRA beneficiaries instead of individuals.

Let’s apply the Court’s definition of “retirement funds” and the above rationale to surviving spouses who inherit IRAs. Again, to quote the Court:

An inherited IRA is a traditional or Roth IRA that has been inherited after its owner’s death. See §§408(d)(3)(C)(ii), 408A(a). If the heir is the owner’s spouse, as is often the case, the spouse has a choice: He or she may “roll over” the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA.

Thus, spousal rollovers are NOT automatic, though they may be accomplished in rather passive manner, such as not taking an RMD or contributing to the account, and therein lies the rub.

The spouse who inherits an IRA did not set aside his or her own funds, and it’s hard to see how spousal inherited IRAs can achieve protection under the Court’s rationale:

In ordinary usage, to speak of a person’s “retirement funds” implies that the funds are currently in an account set aside for retirement, not that they were set aside for that purpose at some prior date by an entirely different person.