Is an inherited IRA safe in bankruptcy? Supreme Court says: no

There are a lot of myths about bankruptcy that make many people hesitant to pursue it as a solution to their financial problems. If the fears about bankruptcy could be summed up in a cartoonish image, it would be of a person being held upside down by his ankles and shaken in order to get all of the loose change to fall from his pockets.

In reality, asset protection is an important benefit of filing for bankruptcy. It allows individuals to discharge most debts while holding onto important assets like their home, car and retirement accounts.

More specifically, you can keep a retirement account that you built and funded such as a 401(k) or other IRA. This is an important distinction because of a recent ruling by the U.S. Supreme Court. The case concerned a woman who inherited her deceased mother’s IRA in 2001 and then needed to file for bankruptcy about nine years later. The question to be decided was: Are inherited IRAs protected during bankruptcy in the same way that self-established ones are?

In a rare unanimous ruling earlier this month, the Court held that inherited IRAs are different and are not protected during bankruptcy. As the name suggests, a regular IRA is money specifically set aside for retirement. As such, you cannot take the money out early without incurring a penalty.

But inherited IRAs differ in several important ways. With an inherited IRA:

• You cannot contribute additional funds into it
• You can withdraw funds without penalty
• IRA heirs must take out a minimum amount each year or withdraw the whole balance within five years after the death of the original owner (these terms apply only to non-spousal heirs)

In short, an inherited IRA seems to behave much more like inherited cash. Because of this, the Court ruled, it does not qualify as a protected asset during bankruptcy.

The nuances of this ruling are somewhat complicated, and there are plenty of others just like it. That’s why you should consult an attorney about your specific financial situation before you decide that bankruptcy is or is not right for you.

Source: Forbes, “Supreme Court Finds Inherited IRAs Not Protected In Bankruptcy,” Deborah L. Jacobs, June 12, 2014