Morris County Bankruptcy Attorney Explains Inherited IRAs
An IRA, or Individual Retirement Account, is a retirement plan that provides tax advantages for retirement savings. Every month that you earn a paycheck, you are entitled to deposit a percentage of your pay into a separate account. Once there, however, your funds must stay put until your retirement, unless you want to pay a decent-sized financial penalty.
There is more than one type of IRA, so you will need to research them and decide which one is the best for you. The four primary types are the traditional, the Roth, the SEP (short for Self Employed Person) and the SIMPLE (short for Savings Incentive Match Plan for Employees). Each kind has its own rules as to how it works, but they all share one very important trait: they are exempt from being part of the bankruptcy estate. This means IRAs, under normal circumstances, are out of the reach of creditors in bankruptcy.
The reason for this is that when one creates a retirement fund through an IRA, that money must be protected in order to assure you have sufficient funds to survive after you pass the age at which you can earn your living.
How Are Inherited IRAs Treated Differently in Bankruptcy?
It is not uncommon for an IRA to be left to a loved one after death. Most simply turn into “inherited IRAs,” no matter which type of IRA was initially created. It is important to understand that inherited IRAs are not subject to the same rules as the other types.
The biggest difference is that an inherited IRA is not actually a “retirement cushion” because the money can, and in fact, must, be regularly withdrawn.
Instead of leaving the funds undisturbed until reaching retirement age, the holder of an inherited IRA must make annual withdrawals, called distributions, from the account. These yearly distributions are classified as taxable income, so simply put: if your funds sit, untouched for decades in an IRA, the IRS cannot take their cut.
Because of this major difference, when it comes to bankruptcy proceedings, inherited IRAs are treated very differently, after a case that went all the way to the Supreme Court.
What Did the Supreme Court Rule About Inherited IRAs and Bankruptcy?
The Court recently heard the case of Heidi Heffron-Clark, who declared bankruptcy in 2010, and claimed the IRA she had inherited from her mother was intended as a “retirement fund.”
But the 35-year-old had already taken over $150,000 in distributions from the account since her mother’s passing, and using that money to live on for almost a decade.
A bankruptcy court initially ruled against the woman, stating in their decision that an inherited IRA was to be used presently, not as a retirement savings fund. When Heffron-Clark appealed, the Supreme Court unanimously agreed that inherited IRAs are not protected in bankruptcy, and their new ruling in the case creates the standard for all future inherited IRAs.
How Can I Best Manage My Inherited IRA?
Since inherited IRAs are not exempt from bankruptcy anymore, your best approach is to treat them as you would any other assets—thoughtfully and prudently.
It is also very important to know at the outset that IRAs inherited from a spouse have different rules than those inherited from relatives or friends. Spouses can take an inherited IRA and essentially treat it just like their own. Non-spouse beneficiaries, on the other hand, must handle inherited IRAs very differently. It is important for you to know what kind of account you have and treat it accordingly.
Regardless of which kind of IRA you have, though, the best plan is to leave the funds in your account for as long as possible. Careful planning will allow your funds to be sheltered from taxation for decades while they grow.
This information is just the beginning when it comes to IRAs, inherited or otherwise. There are many, many ways to handle your retirement assets, and the wisest move you can make is to talk with an experienced attorney, particularly if you are thinking about filing for bankruptcy.
To learn more about how IRAs are affected by bankruptcy proceedings, call a Morris County bankruptcy lawyer today. An experienced New Jersey bankruptcy lawyer can help you understand IRAs and all other aspects of the bankruptcy process.