A recent court of appeals decision was a surprise to both bankruptcy and estate planning professionals when judges decided that creditors in a bankruptcy proceeding could seek access to the funds contained in an inherited IRA account.
The decision is a departure from those in other jurisdictions but raises concerns about the effect it will have nationwide on federal bankruptcy laws and the interaction it could have with state probate and estate laws.
The woman in the case inherited a retirement account from her mother but is otherwise insolvent and sought to restructure her debt through a bankruptcy proceeding. Previous rulings have exempted individual retirement accounts from creditors under the value of enabling people to save for retirement without fear of having their accounts seized. However, the panel in this case said that because the account was inherited from someone else, it was not protected under that rule.
While it does not impact the law here in Florida, the case shows the importance of considering the structure of a gift, not just the gift itself or the amount. While it is difficult to think about our family or friends going through financial hardship, part of the reason why we give these types of gifts is to lend a helping hand in those situations. As such, structuring a gift to create a trust or other type of asset that is protected from creditors can be a major advantage, helping beneficiaries when they need it the most.
In Florida, people who are creating a trust can include what is known as a "spendthrift" provision, which protects the principle amount in the trust from creditors of the beneficiary. This applies in limited circumstances and does not protect the income from the trust entirely.
Source: Thomson Reuters News & Insight, "In circuit split, court says inherited IRA fair game in bankruptcy," Nick Brown, April 24, 2013
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