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Inherited IRAs could be subject to bankruptcy claims, court says

For people who are toeing the edge of financial solvency, any infusion of money can be a blessing. Whether expected or unexpected, having new resources to draw on in order to pay credit card bills, mortgage payments and medical expenses can be a giant relief.

Imagine, then, when that newfound resource is subject to forfeiture as a result of a personal bankruptcy. This is the situation faced by a family who inherited an Individual Retirement Account upon the death of a relative.

For some kinds of bankruptcy, assets that are considered not protected might be used to pay toward some of the debt. Retirement accounts, however, are generally protected and not available to satisfy creditors' requests. Inherited IRAs, however, are a different kind of financial animal. This is because people who inherit IRAs are able to withdraw the money before they reach their own retirement age.

The distinction is a crucial one. A case recently decided by the Supreme Court of the United States hinged on that interpretation of the law. The couple who inherited the IRA in question -- worth about $300,000 -- argued that the account was a retirement account, because that's how it was set up in the first place, and didn't want it taken into account as their bankruptcy case progressed.

A bankruptcy judge ruled against the couple initially, but that ruling was later reversed at the district court level. Then an appeals court ruled against the couple again, setting the stage for the Supreme Court to take on the case. The nation's highest court ruled unanimously that the inherited IRA was not exempt from creditors.

Source: Bradenton Herald, "Court: Inherited IRAs not protected in bankruptcy," June 12, 2014

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