Inherited IRAs are Not Protected in Bankruptcy as “Retirement Funds”

On June 12, 2014, the U.S. Supreme Court decided the case of Clark v. Rameker. The Court held that Inherited IRA’s were not “retirement funds” and therefore, not protected assets in bankruptcy.


The petitioners in the case had filed for Chapter 7 bankruptcy and were seeking to exclude approximately $300,000 from the bankruptcy estate held in an IRA that the wife had inherited from her deceased mother, claiming the “retirement funds” exemption. The Bankruptcy Court held that an Inherited IRA does not have the same characteristics as those in a Traditional IRA and thus, disallowed the exemption. This decision was reversed by the District Court which held that the exemption covers any account in which funds were originally accumulated for retirement purposes. The Seventh Circuit Court disagreed and reversed the District Court’s decision. The Seventh Circuit’s decision created a conflict because the Fifth Circuit had previously held in an earlier case that inherited IRAs were protected. Therefore, the U.S. Supreme Court decided to hear the case to resolve the split.


The Court defined “retirement funds” as sums of money set aside for the day an individual stops working. In support of its position, the Court said there are three legal characteristics of an Inherited IRA that provides evidence that these funds do not contain retirement funds.

  1. The holder of an inherited IRA may never invest/add additional money to the account.
  2. The holder of an inherited IRA is required to withdraw money from the account(s), no matter how far they are from retirement.
  3. The holder of an inherited IRA may withdraw money at any time, for any reason, without penalty.

Additionally, the Court stated that allowing debtors to protect funds in a Traditional or

Roth IRA ensures that they will be able to meet their basic needs during retirement. But there is nothing about an Inherited IRA’s characteristics which prevent or discourage an individual from using the entire balance immediately after bankruptcy for any purpose.

The Court rejected the claim that the funds in the Inherited IRA were “retirement funds” because they could be set aside, at some point, for retirement. The Court said that the possibility that an account holder can leave an inherited IRA intact until retirement and take only the required minimum distributions does not mean that an Inherited IRA bears the three legal characteristics of “retirement funds.” Accordingly, the Court upheld the Seventh Circuit Court’s decision.

Planning Opportunity:

Considering the Supreme Court’s decision, how might someone protect an Inherited IRA from a spendthrift child? The answer could be naming a trust as beneficiary of the IRA for the benefit of the child, with spendthrift language that satisfies state law.

In order to have an inherited IRA you must have a designated beneficiary. Typically, only an individual may be a designated beneficiary. A trust cannot be the designated beneficiary unless four requirements are satisfied:

  1. The trust must be a valid trust under state law,
  2. The trust must be irrevocable or will, by its terms become irrevocable on the death of the IRA owner,
  3. The beneficiary of the trust must be identifiable,
  4. The IRA owner must provide the IRA Trustee or custodian a copy of the trust instrument, or a list of all beneficiaries, and agree to provide a copy of the trust instrument to the IRA trustee on demand, and provide the IRA trustee or custodian with any amendments to the trust in the future.

However, Section 541(c)(2) of the Bankruptcy Code (11 U.S.C. § 541(c)(2)) provides:

(2) A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable non bankruptcy law is enforceable in a case under this title.

What does this section mean in the context of spendthrift trusts which may have language similar to the following?

No part of the income or principal of this trust shall be subject to anticipation, alienation, or assignment by any beneficiary.”

This provision, and others like it, is often used in situations where a beneficiary may not have financial acumen; be unable to manage money or assets; might have a substance abuse problem; may be naïve or easily susceptible to deception or fraud; or might easily spend themselves into debt with creditors. These provisions are intended to protect trust property from a beneficiary’s actions or inactions and/or to protect assets from the beneficiary’s creditors. The trust therefore restricts access to the trust principal by the beneficiary, and thus his/her creditors. Once funds are distributed from the trust, of course, it then becomes subject to creditor claims.

So, if you’re concerned about this Supreme Court decision and potential creditors of your heirs having access to your hard earned IRA, name a spendthrift trust as beneficiary of your IRA, and your heirs can be beneficiaries of the trust.

The foregoing information regarding estate, charitable and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only. I do not provide tax or legal advice tax. You should consult with your tax and legal advisor regarding your individual situation. 

Contact Connie Dello Buono, financial planner for 30min free phone chat with a financial advisor 408-854-1883 CA Life Lic 0G60621

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connie dello buono

Health educator, author and enterpreneur or ; cell 408-854-1883 Helping families in the bay area by providing compassionate and live-in caregivers for homebound bay area seniors. Blogs at Currently writing a self help and self cure ebook to help transform others in their journey to wellness, Healing within, transform inside and out. This is a compilation of topics Connie answered at and posts in this site.

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