A recent Florida case ruled that an inherited IRA was not exempt from claims of the new owner's creditors.

Section 222.21(2)(a) of the Florida Statutes protects money or other assets payable to an owner, a participant or a beneficiary from claims of creditors of the owner, participant or beneficiary if held in a fund or account maintained as an Individual Retirement Account ("IRA"). To qualify, the IRA must be exempt from taxation under the Internal Revenue Code. Section 222.21(2)(a) of the Florida Statutes further provides that an account's tax exempt status determines its exemption from garnishment.

The Internal Revenue Code ("IRC") provides that an IRA is exempt from income tax until a distribution is taken by the account owner during an owner's life. The IRA owners are required to take distributions, may roll over their account and will incur a ten percent penalty for early account withdrawals. Upon the IRA owner's death, however, the tax attributes of the inherited account changes, whereby, account distributions become exempt from any early withdrawal penalty and the inherited account losses its entitlement to rollover treatment.

In Robertson v. Deeb, the creditor (Deeb) obtained both a judgment and writ of garnishment against Robertson on an unpaid promissory note. Deeb was the owner of an inherited IRA account with cash and securities. Robertson claimed the inherited IRA was exempt from garnishment pursuant to section 222.21(2)(a) of the Florida Statutes.

In Robertson, the trial court found that section 222.21(2)(a) was not applicable to an inherited IRA and denied the exemption claim explaining that an inherited IRA is not not like an IRA in terms of taxing and penalty for early withdrawal and the legislature did not intend to protect inherited IRAs.

On review, the Second District Court of Appeals found that when an inherited IRA is distributed to its beneficiary following the death of the original account owner, its creditor exempt status changes. The Court relied upon rulings from several prior bankruptcy court decisions, initially evolving from a United States Bankruptcy Court case in which a chapter 7 debtor claimed an inherited IRA as an exempt asset.

The Court then addressed the issue of whether an IRA loses its exempt status under section 222.21(2)(a) upon the death of the original account owner. The Court acknowledged section 222.21(2)(a) provides for exemption from "all claims of creditors of the . . . beneficiary," however, the court agreed with the trial court that inherited IRAs are not entitled to the exemption set forth in section 222.21(2)(a) which is limited to the "original fund or account."

The Court further emphasized that section 222.21(2)(a) did not specifically exempt inherited IRAs, which are separate funds or accounts created when the original fund or account passes to its beneficiary upon the death of the original participant.

The Court went on to hold that the legislative intent of exempting individual retirement accounts would not be served by protecting an inherited IRA. Specifically, the Court opined, "[t]he purpose of the ... Legislature in exempting individual retirement accounts is to allow debtors to preserve assets which have been earmarked for retirement in the ordinary course of the debtor's affairs. Such a purpose would not be served by upholding [the beneficiary's] request to keep his interest in the IRA as exempt."

This recent Florida case regarding the exemption treatment of inherited IRAs provides guidance that the original owner of an IRA is protected from creditors while a beneficiary who inherits the IRA is not and requires advisors to know about all of a client's retirement accounts and the accounts' history. Importantly, this case dramatically impacts a client's estate planning options and we highly recommend clients consider using a Retirement Trust which would protect the inherited IRA from creditor claims.

Hopefully, many of our readers are aware that the current income limitations on converting a traditional IRA to a Roth IRA will be eliminated in 2010. This removal of the income limitation will allow more current IRA holders to consider the possibility of a switch to a Roth IRA. Here are some important factors to be aware of:

• Withdrawals from a Roth IRA are tax free if made [i] after the Roth IRA has been held at least five years, and [ii] after age 59-1/2 or death. Importantly, early withdrawals are subject to a tax penalty.

• people who will always be in the highest income tax bracket,
• people who will likely be subject to estate tax, or
• someone who is currently in a low income tax bracket but will likely be in a higher income tax bracket in retirement.