A recently decided case of the United States Supreme Court may have far-reaching implications with respect to the manner in which individuals structure their estate plans. The case is titled Clark v. Rameker. It involves the interplay of the bankruptcy laws and the laws governing individual retirement accounts or IRAs.

In this case, Mrs. Clark and her husband filed for bankruptcy. Mrs. Clark had inherited an IRA from her mother, who died in 2001. The inherited-IRA was worth $450,000 at the time Mrs. Clark inherited it from her mother. At the time Mrs. Clark and her husband filed for bankruptcy, the IRA was worth $300,000.

Mrs. Clark sought the benefits of a Bankruptcy Code section that exempts “retirement accounts” from being subject to the claims of creditors in a bankruptcy proceeding. In other words, if the IRA that Mrs. Clark inherited from her mother was a retirement account within the meaning of the Bankruptcy Code, then Mrs. Clark could retain the entire account (worth $300,000) without having to pay a dime of the account to the Clarks’ creditors.

The Supreme Court noted how an inherited-IRA differs from an IRA that an individual establishes for herself in three ways. First, unlike an IRA that an individual establishes for herself, the owner of an inherited-IRA cannot contribute additional funds to the IRA; in other words, Mrs. Clark could not add her own money to the IRA she inherited from her mother.

Secondly, the owner of an inherited-IRA must begin to withdraw money from the account no matter how far they may be from retirement. Once Mrs. Clark inherited the IRA from her mother, she was required to begin to take a minimum required distribution from the inherited-IRA. This is true no matter how old Mrs. Clark may have been at the time she inherited the IRA.

With a traditional IRA, the owner is not required to take minimum required distributions until they attain the age of 70-1/2. With an inherited IRA, the owner must begin taking minimum distributions after they inherit the IRA, irrespective of their age.

Finally, the owner of an inherited-IRA can withdraw all the money from the account at any time and for any reason without penalty. The owner of a traditional IRA cannot withdraw funds from the IRA without penalty until she achieves the age of 59-1/2, unless certain exceptions, such as disability of the owner, are present.

The Court held that inherited-IRAs are not retirement accounts within the meaning of the Bankruptcy Code; accordingly, Mrs. Clark’s inherited-IRA is subject to the claims of her creditors. In short, Mrs. Clark cannot shield her inherited-IRA from her debts.

This case can have far-reaching implications on estate planning. For instance, what if Mrs. Clark’s mother had devised her IRA to a spendthrift trust for her daughter’s benefit instead of passing the IRA directly to her daughter. Such a trust would have isolated the IRA from Mrs. Clark’s creditors.

With such a trust, Mrs. Clark would not have to pay the IRA over to her creditors and could enjoy the money for the remainder of her life. Care will need to be taken in drafting estate plans when IRAs involved.

Inherited IRAs come with unique rules that can affect taxes and planning decisions. Understanding those differences helps you avoid mistakes and make the most of the account.