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Supreme Court rules inherited IRA not protected in bankruptcy

For many New York residents personal bankruptcy is a necessary step in getting through difficult financial situations. Unlike foreclosure, creditor harassment and other negative events that can result when debts are neglected, taking the initiative to file for Chapter 7 or Chapter 13 bankruptcy can be a proactive move for a more secure future. Bankruptcy can provide a person with legal protections that guarantee some of his wealth will be preserved in the future.

In many bankruptcy cases individuals are allowed to protect their retirement accounts from liquidation. The idea here is that a person has had the foresight to save for the future and as such should not be penalized if that money is not accessible until well into the future. Individual Retirement Accounts, also known as IRAs, generally fall into this protected category.

Some people are fortunate enough to acquire IRAs through testamentary channels. They may receive an IRA through a parent's will or inheritance. A recent decision of the United States Supreme Court calls into question whether these inherited IRAs are also safe under federal bankruptcy laws.

In the relevant case, a woman inherited an IRA from her mother. The woman could draw upon the account without penalty regardless of her financial challenges and had collected earnings on the account. She claimed in bankruptcy that the account should be protected as it was a retirement account but the court did not agree.

The woman did not work to create the account and the funds in it were accessible to her, and therefore it was not exempt, the court reasoned. Though state laws can sometimes protect inherited IRAs in bankruptcy, this case shows that each bankruptcy case is unique and can be interpreted under the law in distinct ways.

Source: Financial Planning, "After High Court Ruling, How to Protect Clients," Ed Slott, July 22, 2014

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