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Can creditors take assets from an inherited retirement account?

On Behalf of | Dec 20, 2021 | Estate Planning |

One of the key goals of many people as they develop their estate plan is protecting the assets they leave their loved ones from going to taxes, creditors, ex-spouses and wasteful spending. There are ways to set up trusts that will protect your heirs and your money.

What about individual retirement accounts (IRAs)? Many people assume that since an IRA is typically protected from creditors and bankruptcy claims, that protection extends to the person who inherits it. However, the law doesn’t offer that same protection for inherited IRAs — if the beneficiary is anyone other than the surviving spouse.

A key ruling by the U.S. Supreme Court is often cited in discussions of this question. In 2014, the court ruled that inherited IRAs were not exempt from being seized by the beneficiary’s creditors. The reasoning was that while an IRA is a retirement account for its original owner, it doesn’t necessarily serve that purpose for the person who inherits it.

As we noted above, if a surviving spouse inherits an IRA, they are protected against claims by creditors. That’s true even if they roll it over into an IRA in their own name.

What about 401(k)s?

An employer-sponsored 401(k) might have more protection for the beneficiary, at least until they’re rolled over into an IRA as required. However, this still seems to be a matter for the courts – and a matter of timing. In a recent case, a federal bankruptcy court ruled that assets a person inherited could not be claimed by creditors because they had not yet been distributed from the 401(k) to a rollover IRA at the time of the bankruptcy proceedings.

Retirement accounts are governed by unique and often confusing federal and state laws. Even though they hold the bulk of most people’s savings, the myriad regulations that govern them are often difficult to understand. As you develop your estate plan and determine how your assets will be distributed, it’s crucial to take special precautions if any of your loved ones have credit or bankruptcy issues to protect the assets you leave behind.