July 2, 2014
By Mary Patricia Magee and Andrew J. DeMaio
The United States Supreme Court decision in Clark v. Rameker has spurred interest in creditor protection for inherited IRA accounts. The Court held that an inherited IRA (an IRA remaining in tax-deferred status for the benefit of a beneficiary after the death of the account participant) does not satisfy the definition of “retirement funds” under federal bankruptcy law and is therefore not exempt from claims in bankruptcy proceedings.
Most states have laws that exempt IRA accounts from the claims of creditors, independent of bankruptcy law. Some of those laws specifically protect inherited IRAs. For example, a Texas statute protects “an individual retirement account or individual retirement annuity, including an inherited individual retirement account…” The comparable Alaska statute explicitly includes “a retirement plan if the beneficiary acquired the interest as a result of the death of an individual…”
In New Jersey, N.J.S. 25:2-1b protects assets “held in a qualifying trust” from creditor claims. It defines a “qualifying trust” as a trust created or qualified and maintained pursuant to federal law, including, but not limited to, section 401, 403, 408, 408A, 409, 529 or 530 of the federal Internal Revenue Code of 1986 (26 U.S.C. § 401, 403, 408, 408A, 409, 529 or 530).
The New Jersey exemption statute, unlike the federal bankruptcy exemption, is not limited to retirement funds. The New Jersey statute includes accounts created and maintained under tax code sections 529 and 530, which deal with savings for education rather than retirement.
Even though the statute does not specifically use the term “inherited IRA” or refer to the death of the owner, it appears that the law applies to inherited IRA accounts as well as other tax-qualified plans. An inherited IRA continues to be “qualified and maintained pursuant to federal law” even after the death of the account owner. Internal Revenue Code section 408 defines an IRA as an account “created or organized in the United States for the exclusive benefit of an individual or his beneficiaries…” And section 408 specifically refers to “an inherited individual retirement account” and contains detailed rules on the taxation of distributions from such an account.
Although inherited IRA accounts appear to be protected from creditor claims under New Jersey law, residents of the Garden State may still want to consider the option of naming a trust as the beneficiary of an IRA rather than an individual or individuals. That is because the extent to which the account is protected from creditors of the beneficiary will depend on where the beneficiary lives, not where the account owner resided. A trust can provide creditor protection for a beneficiary who settles in a state that does not protect inherited IRAs.