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Posted by: Charles P Myrick CPA Posted on: Nov 11 2014

Which IRA No Longer Qualifies for Bankruptcy Protection?

There are few limitations to the bankruptcy protection from creditors traditionally afforded to retirement funds. This protection extends to funds in all government-qualified pension plans, including IRAs (traditional and Roth), 401(k)s, 403(b)s, Keoghs, profit sharing, money purchase, and defined benefit plans. However, the U.S. Supreme Court recently ruled that an inherited IRA is not a "retirement fund" and therefore doesn't qualify for bankruptcy protection.

An inherited IRA is a traditional or Roth IRA that a deceased owner has bequeathed to a beneficiary. It differs from the "true" retirement account in three ways:

  1. 1. The beneficiary is not allowed to contribute additional retirement funds to the inherited IRA.
  2. 2. The beneficiary, regardless of age, may withdraw funds from an inherited IRA in any amount and at any time without penalty.
  3. 3. The beneficiary, regardless of age, is required to take annual minimum distributions from any inherited IRA.
Based on these differences, the Court unanimously concluded that with respect to beneficiaries, inherited IRAs are "not funds objectively set aside for one's retirement." The IRAs constitute a "pot of money that can be used freely for current consumption."

Although the Court didn't specifically address it, there is a possible option available if (and only if) the beneficiary is the spouse of the decedent. Spouses are permitted to roll over funds from inherited IRAs into their own IRAs, which would presumably bring those funds back under bankruptcy protection. The funds would, however, become subject to the rules that apply to non-inherited IRAs, such as penalties for withdrawals before age 59½.

Certain other strategies may be available. If you have inherited or are likely to inherit an IRA and you are interested in possible bankruptcy protection, contact Washington DC tax preparation firm, Myrick CPA.