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Supreme Court: Inherited IRAs non-exempt in bankruptcy

This spring, we wrote about a Wisconsin-based bankruptcy case that made its way to the nation’s highest court. At issue in the case is whether money inherited from another person's individual retirement account (IRA) is shielded from creditors in bankruptcy proceedings.

Before we dive into the case, here is a little more background: During the Chapter 7 bankruptcy process, a trustee is appointed by the court to find any assets owned by the filer that could potentially be used to pay back creditors. However, there are many exemptions under the U.S. Bankruptcy Code, including retirement accounts. 

Essentially, filers are allowed to keep up to $1,245,475 of retirement savings in an IRA so that they are able to provide for themselves post-retirement.

In 2010, when a Wisconsin couple decided to file for Chapter 7 bankruptcy protection, they listed a retirement account that the wife had inherited from her mother as an “exempt asset,” which meant they wanted it protected from their creditors.

But the bankruptcy court did not accept the classification and said that the inherited IRA was non-exempt. The woman then appealed the decision, and federal district court reversed the holding. After another appeal, the 7th U.S. Circuit Court of Appeals ruled that the inherited IRA was non-exempt.

The U.S. Supreme Court then agreed to hear the case, likely because this could become a more common issue as the aging baby boomer generation begins to pass on, leaving unspent retirement assets to their children and loved ones.

In a decision that was announced last week, the Supreme Court held that inherited IRAs are not protected from creditors during bankruptcy like regular IRAs because the status of the funds changes. Inherited IRA funds can be withdrawn at any time, unlike original IRAs.

This crucial change in status makes the inherited IRA funds accessible to creditors, Justice Sonia Sotomayor wrote on behalf of the Court.

Source: Wisconsin Law Journal, “US high court: Inherited IRAs not protected in bankruptcy (UPDATE),” June 12, 2014; Market Watch, “Inherited IRAs lose bankruptcy protection,” Jeffrey Levine, June 13, 2014

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