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Your IRA, Your Beneficiaries and Creditors

The United States Supreme Court recently ruled that funds held in an “inherited IRA account” are not exempt from the bankruptcy estate of the individual for whose benefit the funds are held.  (Clark v. Rameker)  This is a significant ruling for individuals who own IRA accounts and who are designating one or more beneficiaries of those IRA accounts to succeed to ownership of the funds in the accounts at the death of the owner.

But it is now clear that creditors of a non-spouse beneficiary who inherits an IRA account – even if the IRA account is maintained as an “inherited IRA account” for the benefit of the person who inherited it – may reach the inherited IRA account to satisfy a judgment against the person who inherited the IRA.

Accordingly, if you are designating a person or persons (other than your spouse) as the beneficiary or contingent beneficiary of an IRA account that you established (or rolled over from your deceased spouse), and if you are concerned that the person or persons you wish to designate as beneficiary may have financial problems that might result in such person having judgment creditors or needing to declare bankruptcy, then you should consider the possibility of naming as beneficiary of your IRA account a trust for the benefit of such person, instead of naming the person directly as beneficiary.

But be careful.  When naming a trust as the beneficiary of an IRA account, there are specific provisions that need to be included to assure that the individual who is the beneficiary of the trust will enjoy the same income tax treatment as if being named directly as a beneficiary, and there are also special provisions that need to be added to be sure that the beneficiary’s creditors will not be able to reach the assets of the trust.