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Inherited IRAs not Exempt in Bankruptcies, Says Supreme Court

July 13, 2014

Last month, the United States Supreme Court made a decision which has drastic financial ramifications for a large number of people across the country.

Their decision, which was unanimous, was related to an inherited individual retirement account (IRA), and how it falls in with a bankruptcy plan. Normally, IRA accounts are considered retirement funds, and are usually classified as exempt assets. In this case, however, the Supreme Court disagreed, since it was an inherited IRA and not the individual’s own retirement money.

The reasons they classified the inherited IRA as not a retirement account are as follows:

  • The recipient of an inherited IRA is not legally allowed to add any money to it,

  • inherited IRAs generally require that the beneficiary start to take certain established “minimum distributions” the year after they receive the inherited IRA, and

  • inherited IRA funds can usually be taken in their full value at any time, with no penalties whatsoever.

Those 3 key differences outlined lead the Supreme Court to classify inherited IRAs as fundamentally different from traditional IRAs, and therefore the tax-exempt status does not apply.

This can have serious ramifications for anyone planning to pass their IRA to their children in an estate plan. The last thing any parent would want to see if for a retirement account to be snatched away from their children by creditors, leaving them penniless and unprepared for the future.

Fortunately, this ruling only applies on a federal level, so individual states can formulate their own laws if they disagree with the ruling. So far, 8 states have determined that inherited IRAs are exempt in bankruptcies (CT is not one of them), and it is expected that more states will follow suit.

Do not wait for that day, however. You and your attorney will need to take steps to prepare for this change immediately. You do have options as to how you can avoid problems with inherited IRAs, but they vary case by case.