Substantial planning should be undertaken to utilize the various asset protection provisions of the U.S. Bankruptcy Code and State law. The Bankruptcy Code allows debtors to protect certain assets from the reach of creditors, and one of the most important assets that can be protected is the person’s retirement account. Under Section 522 of the Bankruptcy Code, the retirement funds of the individual are exempt and protected from creditor claims. The underlying policy is that a debtor should be allowed to protect herself and not become destitute in her retirement years.
Persons under stress from creditors have been encouraged to fund their retirement accounts prior to bankruptcy to protect themselves in their later years.
This area of the law is well defined. In 2014 the U.S. Supreme Court was presented with the question whether a retirement account inherited from the parents by a child is also protected from child’s creditors. In other words, if the child is running into financial distress and inherits a retirement account from her parents, does the Bankruptcy Code protect the child from the claims of the creditors.
The U.S. Supreme Court determined that an inherited IRA by a child is not treated like the retirement of the parents. The child does not have the same protections under the Bankruptcy Code as would the parents, and the inherited IRA then can be reached by the child’s creditors. The Court’s reasoning was that money contributed to the IRA was for the benefit of the parent to protect the parent in her retirement years, but that same policy consideration should not shelter the retirement account inheritance from creditors of the child.
The teaching is that if a child beneficiary is having financial problems, Mom and Dad should draw down the IRA for their own retirement and be particularly careful about naming a child as a beneficiary who is in financial distress. The estate planning process should take into consideration the competing interests of the parents to maintain their lifestyle for their life time and take into consideration the problems of the financially distressed child.
While the Supreme Court did not address the issue given the reasoning of this case, if a beneficiary under a retirement is a surviving spouse who is in financial distress, the inherited IRA should also be protected from the reach of creditors of the surviving spouse. In other words, if the surviving spouse runs into financial difficulty or is being pursued by creditors, a strong argument can be made that the retirements funds of the surviving spouse are also beyond the reach of creditors.
Lat J. Celmins