The estate planning process can be overwhelming. Estate planning is crucial to prevent problems, protect your assets, and plan for the future. This process can be more all the more complicated when bankruptcy issues come into play. An estate planning can help you navigate potential problems and manage your assets to preserve your wealth and minimize certain tax ramifications.
A recent decision handed down from the U.S. Supreme Court highlights how the bankruptcy process can expose the harmful effects of improper estate planning.
Improper estate planning and bankruptcy
In Clarkv.Rameker, etal., Ruth Heffron held a traditional IRA and named her daughter as the sole beneficiary of the account. When Ms. Heffron died in 2011, her daughter inherited the IRA account, which was valued over $450,000. The daughter elected to receive monthly distributions.
In 2010, the daughter filed a Chapter 7 bankruptcy petition. At the time of the filing, the IRA was worth about $300,000. The daughter sought to exempt the inherited funds under a bankruptcy exemption. The Bankruptcy Code allows debtors to exempt certain “retirement funds” from the reach of creditors.
The bankruptcy trustee and unsecured creditors objected to the daughter’s attempt to exempt the inherited IRA funds from the bankruptcy estate. These parties claimed that an inherited IRA fund is not the type of “retirement fund” that falls within the meaning of the bankruptcy exemption.
In reviewing the case, the Supreme Court posed the following question:
“[W]hether funds contained in an inherited individual retirement account (IRA) qualify as ‘retirement funds’ within the meaning of this bankruptcy exemption.”
The Supreme Court answered, “they do not.” In reaching its holding, the Supreme Court looked at the ordinary meaning of “retirement funds” to be “sums of money set aside for the day an individual stops working.” The Supreme Court concluded that inherited IRAs are not set aside for the purpose of retirement. Specifically, the Supreme Court reached its conclusion by recognizing three differences between inherited IRAs and traditional and Roth IRAs.
First, unlike a Roth or traditional IRA, the Supreme Court recognized that an account holder for an inherited IRA may never invest additional money into the account. Second, an inherited IRA account holder is required to withdraw all funds within five years or is required to receive monthly distributions. Finally, an inherited IRA account holder may withdraw all the funds at any time without penalty, which is in stark contrast to traditional or Roth IRAs that encourage funds to be deposited and untouched until retirement.
As a result, the daughter’s inherited IRA account was not exempt from the bankruptcy estate and was subject to the reach of creditors. With proper estate planning, the mother could have protected her IRA assets by placing her IRA into a trust, as opposed to directly naming her daughter as the beneficiary.
Contact an estate planning attorney
This case highlights how failing to develop a proper estate plan can have harmful effects in the future. Janathan L. Allen, APC has extensive experience assisting clients in effective estate planning. Contact a San Diego estate planning lawyer today for a free initial case consultation.