Inherited IRAs Are Not Exempt From Bankruptcy

In Bankruptcy, General, Tax by Coolidge Wall

When filing for bankruptcy, a person may exempt “retirement funds” from the bankruptcy estate. However, last week the Supreme Court decided that the term “retirement funds” does not include funds in an inherited IRA.

An inherited IRA is a traditional or Roth IRA that a person has inherited from the original owner. Inherited IRAs are different from traditional or Roth IRAs. First, the person who inherited the IRA must withdraw the funds within five years of the original owner’s death or take annual minimum distributions regardless of the age of the person. Additionally, the person can withdraw funds at any time without paying a penalty. Finally, the person inheriting the account may not make additional contributions to the account.

Since the Bankruptcy Code does not define “retirement funds,” the Supreme Court defined retirement funds as a sum of money set aside for when a person stops working. The Court concluded that the differences between traditional or Roth IRAs and inherited IRAs demonstrate that the funds in an inherited IRA are not retirement funds since the funds are not set aside for when a person stops working.

The Court stated that allowing a bankruptcy debtor to protect funds held in traditional and Roth IRAs would let a debtor meet basic needs during retirement. However, the Court refused to exempt inherited IRAs since nothing about an inherited IRA would prevent the individual from using the entire balance of the account on a vacation home or a sports car immediately after the completion of the bankruptcy proceeding.

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