You work hard to put away money in your individual retirement account. If there are still funds remaining in that fund when you pass away, the person designated as your beneficiary will have access to the funds. It is important that you choose someone who is financially responsible as the beneficiary because all your hard work saving money will be for nothing if the beneficiary files for bankruptcy after inheriting the IRA. You should also remember that beneficiary designations on IRAs trump any instructions left in your will.
A woman filed for bankruptcy while she was in possession of a $300,000 inherited IRA left to her by her mother. She petitioned the court to protect the IRA because it is technically a retirement account. The case ended up going before the Supreme Court. That court ruled that inherited IRAs aren't protected during bankruptcy.
This ruling allows creditors to stake a claim to the retirement account that was inherited in an effort to get the creditors paid off. The Supreme Court noted that the reason for the lack of protection is that while an inherited IRA is still a retirement account, the holder of the IRA doesn't have to wait until they are of retirement age to cash in the IRA. Instead, they can cash it in as soon as the bankruptcy is complete to purchase a car or take a vacation.
Those who are updating or creating an estate plan should make sure they also update the beneficiary on IRAs and other accounts to ensure their final wishes are followed with the funds. Failing to appoint a responsible beneficiary could mean that all your hard work saving money was wasted.
Source: Reuters, "Inherited IRAs in play for bankruptcy creditors: U.S. high court" Nick Brown, Jun. 12, 2014