Why Clark v Rameker Matters To Your Children: Protecting Retirement Funds for your Heirs

Retirement plan assets have become a major factor in the USA, amounting to approximately $23 trillion as of the end of 2013. Many individuals and estate plans use IRA accounts and other retirement funds as an integral part of succession planning. And such a big chunk of funds is always going to be a target.

On June 12, 2014 the U.S. Supreme Court unanimously ruled in Clark v. Rameker that an inherited IRA is not exempt from claims of creditors under the Bankruptcy Code provisions that generally exempt “retirement funds” from claims of creditors. There are numerous creditor-protections that protect retirement funds from creditors. Now, not all retirement funds, not all creditors, not in every circumstance. If you have creditors knocking at your door, you need particular advice for your situation—and you should not waste time getting it. But in general, retirement funds enjoy numerous protections.

The question has been: do inherited retirement accounts enjoy the same protections? Many people have wrongly assumed this to be the case, with the result that they will tell you to go ahead and name your kids as beneficiaries on your retirement accounts…this is the best thing to do…it is perfectly safe. Before the June decision in Clark, whether or not they were right depended in part upon where you were standing in the United States when you asked the question.

But now the United States Supreme Court has spoken, and it turns out these people were wrong all-along. On June 12, 2014 the US Supreme Court shook the financial world with Clark v Rameker.  In Clark the court held 9-0 that inherited retirement accounts are NOT exempt from the claims of the bankruptcy trustee (and other creditors). You can read it here.

Here is the short-version of the story: During her life Ruth Heffron established an IRA and named her daughter Heidi Clark as the beneficiary upon her death. People do this every day. When Ms. Heffron died in 2001, Heidi inherited Mom’s IRA under the beneficiary designation and rolled it into an IRA in Heidi’s name. Happens every day.

Fast-forward to 2010, when Heidi and her husband filed chapter 7 bankruptcy and sought to exempt the roughly $300,000 in the IRA, which Heidi had inherited from her mother’s IRA, under a provision of the bankruptcy code (specifically, 11 USC §522(b)(3)(C)) that affords creditor protection for many (but not all) retirement accounts from most (but, again, not all) creditors. On behalf of the creditors, the Trustee (William Rameker) challenged the exemption.

In the end the bankruptcy court refused to allow the exemption, and the Clarks appealed to District Court…and on it went to the US Supreme Court. In plain, if perhaps slightly oversimplified English, the court held that inherited IRAs are simply not the same as money an individual has set aside for the day that individual stops working, and the owner of inherited IRA can withdraw the money at any time without penalty (though, of course, taxes are due). Apparently, as the court sees it, the creditor-protection exists to prevent late-in-life poverty for that individual, the person inheriting the IRA is not relying on the money the same way.

So what do we do?

What is clear: The court has made it clear that IRAs that name children as beneficiary enjoy almost no protection from the child’s creditors under federal law. It is fairly clear that this result would extend to any sort of inherited retirement account. Now there is spotty protection under state law in a few states, including North Carolina, if the heir happens to live in one of those states. But it is spotty, could easily change in light of Clark, and anyway people move around a lot. So relying on state law protections is a real gamble.

What is not clear: Are retirement accounts inherited by a surviving spouse protected from creditors? The Clark case does not address that. Logic applied to the reasoning in Clark would say spouses do NOT enjoy protection, either. But the law is not always logical and it may well not work out that way. This is a big deal, but at present the law is very unclear. We will deal with that thorny issue in a later post.

For now, what we can say is that you probably should NOT name your children (or anyone other than a spouse) as beneficiary (or contingent beneficiary) of your retirement account(s) directly unless it is a VERY small sum of money or you are VERY unlikely to die (I would like to get in on that one), or you just don’t care what happens.

The ideal solution would be to name a stand-alone IRA Beneficiary Trust as beneficiary of your retirement accounts. I discuss such a trust in our Estate Planning FAQ section and have written about them and their benefits elsewhere. If properly done, this will protect retirement funds left to any beneficiaries (spouse, children, cats) from their creditors.

It also presents numerous other advantages. There is NO one-size-fits-all package for estate planning. As we say over and over, the key to estate planning is planning. But this is a great option for many who want to insure that hard-saved retirement funds improve the life of their family and not the bottom-line of a creditor or of some other predator.

Another option is to name your properly-drafted revocable living trust (RLT) as beneficiary (using conduit provisions). This does not have nearly the level of protection as the stand-alone IRA trust. But it is simpler and it does help quite a bit, and it may be appropriate for you. It is certainly far preferable to naming beneficiaries directly in most (not quite all) circumstances.

The worst thing you can do is nothing. You have worked too hard for your money, and your family is too important to ignore the issue. This is why estate planning is critical. Call us, we can answer your questions about protecting retirement funds and other estate planning issues, and then craft and implement an estate plan that meets your needs and achieves your goals. Call us today to start the discussion.