On June 12, 2014, the U.S. Supreme Court resolved a key question that has lingered for nearly a decade: Are funds in an inherited IRA protected in bankruptcy? The answer was a unanimous, “No.”
One of the most important, and commonly used, exemptions from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is the exemption from a bankruptcy estate of retirement funds. Specifically, 11 U.S.C. 522(b)(3)(c) shields retirements funds from judgment creditors in bankruptcy. Last Thursday, however, the Supreme Court gave a significant victory to creditors by substantially limiting this exemption.
When an individual debtor files a bankruptcy petition, her “legal or equitable interests . . . in property” become part of the bankruptcy estate. 11 U.S.C. §541(a)(1). “To help the debtor obtain a fresh start,” however, the Bankruptcy Code allows debtors to exempt from the estate limited interests in certain kinds of property. Rousey v. Jacoway, 544 U. S. 320, 325 (2005). The exemption at issue in Clark v. Rameker allows debtors to protect “retirement funds to the extent those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code.” §§522(b)(3)(C), (d)(12).
An inherited IRA is a traditional or Roth IRA that has been inherited after its owner’s death. See §§408(d)(3)(C)(ii), 408A(a). If the heir is the owner’s spouse, as is often the case, the spouse has a choice: He or she may “roll over” the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA. See Internal Revenue Service, Publication 590: Individual Retirement Arrangements (IRAs), p. 18 (Jan. 5, 2014). When anyone other than the owner’s spouse inherits the IRA, he or she may not roll over the funds; the only option is to hold the IRA as an inherited account.
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