Supreme Court Rules That Inherited IRAs Are No Longer Protected From Bankruptcy

Washington DC Bankruptcy Lawyer Weighs In on Inherited IRAs

Simply put, an IRA is an Individual Retirement Account, or a retirement plan that provides tax advantages for retirement savings. Each month that a person earns a paycheck, a percentage of their pay is deposited into a separate account. Once there, the funds cannot be withdrawn before retirement without incurring a hefty fine.

There are several types of IRA, including the traditional IRA, the Roth IRA, the SEP IRA and the SIMPLE IRA. Each type has different rules as to how it works, but they all share an exemption from bankruptcy status. The reasoning is that when one contributes to an IRA for future use during retirement, those funds must be protected in order to assure sufficient funds to live on after passing the age at which one can work for a living.

It is quite common for an IRA to be left to a loved one after death. Regardless of which type of IRA was initially created, most of these become known as “inherited IRAs” and are not subject to the same rules as their predecessors. (Roth IRAs have slightly different tax rules.)

The major difference between an inherited IRA and all other kinds of IRAs is that instead of not touching its’ funds until retirement, the holder of an inherited IRA must make regular withdrawals (called distributions) from the account. The primary reason for this is that every distribution is taxed.

Since the money in such accounts can be freely withdrawn and used to cover any costs the holder chooses, the IRA does not actually function as a “retirement cushion.”

Because of this, the Supreme Court has heard a case and ruled that inherited IRAs are not protected in bankruptcy proceedings.

When Heidi Heffron-Clark declared bankruptcy in 2010, she claimed the IRA she inherited from her mother was intended as “retirement funds,” meaning the money could not be used to pay debts they owed.

But the 35-year-old woman had already drawn $150,000 in distributions from the account since her mother’s death in 2001, using that money to live on for nearly a decade.

The bankruptcy court ruled against Heffron-Clark, declaring that an inherited IRA represented “an opportunity for current consumption, not a fund of retirement savings.” Upon appeal, the Supreme Court unanimously agreed, and their ruling in the case has created the standard for all inherited IRAs moving forward.

What Is the Best Way To Manage My Inherited IRA?

Since the Supreme Court has decreed that inherited IRAs are no longer exempt from bankruptcy, it is best to treat them as you would any other assets—with care and caution.

IRAs inherited from a spouse have different rules than those inherited from relatives or friends; spouses can take the account and essentially treat it just like their own, while non-spouse beneficiaries must handle IRAs differently. It is important for you to understand what kind of account you have inherited and treat it accordingly.

Ultimately, the best approach is to let the money rest in your inherited IRA for as long as possible. Patience and thoughtful planning will allow a beneficiary to shelter their funds from taxation for decades while they grow.

This information is just the tip of the iceberg when it comes to IRAs, inherited or otherwise. There are myriad ways to handle these assets, and the smartest thing you can do is talk to an experienced professional, particularly if you are considering filing for bankruptcy.

To learn more about how IRAs are affected by bankruptcy proceedings, contact a bankruptcy lawyer to help you understand IRAs and all other aspects of the bankruptcy process. Our attorney practices in Washington DC and throughout Maryland.

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