In general, a person’s retirement funds, including their funds held in an Individual Retirement Account (IRA), are protected in bankruptcy proceedings. However, until recently, courts across the country reached conflicting decisions regarding whether funds held in an IRA inherited by someone after the initial account owner’s death (an “inherited IRA”) were protected in bankruptcy. On June 12, 2014, the United States Supreme Court ruled on whether funds held in an inherited IRA are protected in bankruptcy and exempted from a debtor’s bankruptcy estate. The Court unanimously held that funds in an inherited IRA are not exempt from a person’s bankruptcy estate. In reaching this holding, the Court distinguished an inherited IRA from other “retirement funds” that may otherwise be protected in bankruptcy.
After considering the arguments for and against protection of an inherited IRA in bankruptcy, the Court ultimately reasoned that the bankruptcy statutes did not specifically extend to an inherited IRA and that protecting an inherited IRA in bankruptcy would not further the “fresh start” intent behind the bankruptcy laws. The Court also reasoned that an inherited IRA does not contain “retirement funds” because an inherited IRA is not an asset that the person who inherited it created for his or her own retirement. Rather, an inherited IRA is an asset that was built up for another person’s retirement and then was given to the new owner after the original investor’s death. Thus, as inherited IRAs do not contain “retirement funds,” they are not protected under the “retirement funds” exemption in bankruptcy.
There is, however, one narrow exception to the Court’s ruling that arises when an IRA is inherited by the account owner’s surviving spouse and the surviving spouse follows necessary procedures to elect to treat the IRA as his or her own or to “rollover” the funds in the inherited IRA into his or her own IRA. When a surviving spouse properly treats an inherited IRA as his or her own or “rolls over” the inherited IRA into his or her own IRA, then those funds would likely be treated as his or her “retirement funds” and protected in the event that he or she filed for bankruptcy. Of course, if a surviving spouse elects to retain the inherited IRA as an inherited IRA, then the Court’s holding that inherited IRAs are not protected in bankruptcy would apply.
The Court’s opinion clarifies that funds held in an inherited IRA are not a protected in bankruptcy. That means that an inherited IRA may be subject to the claims of creditors just as other assets of an individual in bankruptcy. Individuals who inherit an IRA should carefully consider the Court’s holding in planning in light of their own estate planning and retirement goals.
The estate planning group at Davies Pearson will ensure that your needs and the needs of your family are met.