Are Inherited IRAs Protected from Creditors? - Fafinski Mark & Johnson, P.A. (2024)

FAQs

Are Inherited IRAs Protected from Creditors? - Fafinski Mark & Johnson, P.A.? ›

In one word, no. Recently, in a unanimous decision, the U.S. Supreme Court held that inherited IRAs are not “retirement funds” within the meaning of federal bankruptcy law; therefore, they are available to satisfy creditors' claims.

Therefore, the PA Superior Court has held that inherited IRAs do not count as “retirement funds” and that they can be reached by judgment creditors.

In Clark v. Rameker (2014), the United States Supreme Court ruled that inherited IRAs are not considered “retirement funds” as defined in 11 U.S.C. 522(b)(3)(C) of the Bankruptcy Code. Therefore, inherited IRAs do not have the same protection from creditor claims as other retirement accounts.

With the right planning, you can protect the IRA that you leave to your children in case of a bankruptcy. One way to do this is to create an IRA trust and name the trust the beneficiary of your IRA. Make sure that you consult a knowledgeable attorney to counsel you and, if appropriate, to draft an IRA trust.

The taxable amount is reported on Form 1040, Page 1 and is not reported on Form 8606. Attach a separate Form 8606 to the return to report the basis of the inherited IRA.

Under longstanding Pennsylvania law, retirement savings vehicles like individual retirement accounts (IRAs), 401(k) and 403(b) accounts, pensions, and employee stock ownership plans (ESOPs) are generally exempt from creditor claims.

The safest states to live in for protecting IRA funds include Arizona, Texas, and Washington. Arizona state laws only allow the judgment creditor to seek retirement funds during bankruptcy from the last 120 days of contributions, meaning everything prior has 100% legal protection.

To make sure that a rollover IRA from a qualified retirement plan is protected in a bankruptcy, it helps to create a separate account just for those assets.

Creditors may target funds in traditional and Roth IRAs and certain 403(b) plans, which are typically not protected under ERISA.

An IRS levy permits the legal seizure of your property to satisfy a tax debt. It can garnish wages, take money in your bank or other financial account, seize and sell your vehicle(s), real estate and other personal property. Retirement accounts, including IRAs, are not exempt from an IRS levy.

What is the new IRS rule for inherited IRAs? ›

The 10-year rule requires that all assets in the inherited IRA must be fully withdrawn by the end of the 10th year following the original IRA owner's death. (If the death occurred in 2019 or earlier, the 10-year rule was a five-year rule.)

Also sometimes called a beneficiary IRA, an inherited IRA is an account that is opened when someone inherits an IRA after the original owner dies.

Whether an heir must pay an inheritance tax on an inherited IRA depends on the age of the IRA owner when they pass away and the individual who inherits the IRA. If an IRA owner passes away before they reach the age of 59 1/2, the IRA given to a beneficiary will not be subject to Pennsylvania's inheritance tax.

Failure to file Form 8606 for a distribution could result in the IRA owner (or beneficiary) paying income tax and the additional 10 percent early distribution penalty tax on amounts that should be tax-free.

An inherited IRA may be taxable, depending on the type. If you inherit a Roth IRA, you're free of taxes. But with a traditional IRA, any amount you withdraw is subject to ordinary income taxes.

Use Form 8606 to report: Nondeductible contributions you made to traditional IRAs. Distributions from traditional, SEP, or SIMPLE IRAs, if you have ever made nondeductible contributions to traditional IRAs. Conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs.

Pennsylvania exempts from execution on judgment on a contract all wearing apparel of the debtor and his family, bibles and school books in use in the family, as well as $300 worth of any property owned or in pos- session of the debtor.

Consider Retirement Accounts and Life Insurance Policies

In Pennsylvania, these assets are generally protected from claims by creditors as long as they are properly designated and structured.

Whether an heir must pay an inheritance tax on an inherited IRA depends on the age of the IRA owner when they pass away and the individual who inherits the IRA. If an IRA owner passes away before they reach the age of 59 1/2, the IRA given to a beneficiary will not be subject to Pennsylvania's inheritance tax.

Creditors may target funds in traditional and Roth IRAs and certain 403(b) plans, which are typically not protected under ERISA.