Supreme Court Decides That Inherited IRAs Are NOT Retirement Accounts

On June 18th, the U.S. Supreme Court decided that, for the purpose of federal bankruptcy law, an inherited IRA in no longer considered a "retirement account" and is therefore accessible to creditors in a bankruptcy.

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act had exempted "retirement funds" up to an inflation-adjusted $1 million in value, and an unlimited exemption for employer-sponsored (e.g., 401(k)) accounts. Several bankruptcy cases since then have been inconsistent in their handling of IRA accounts inherited by beneficiaries, until one case made it to the Supreme Court. The Court decided that an inherited IRA was no longer a retirement account, and therefore not included in the exemption. For a more detailed explanation, you could go to Inherited IRAs Are Not Retirement Accounts on the Slott Report web site.

I'm not a lawyer, I don't play one on TV, and I didn't stay in a Holiday Inn Express last night, so don't depend on me for legal advice. However, from a financial planning perspective, this brings a new issue into the discussion of who and how you want your retirement accounts to pass to your heirs. While the Court did not specifically rule on spousal inheritance, it is generally expected that the rule will not apply to spousal inheritance (I'm not a lawyer, ... yada yada yada). Also, under other laws, a spouse can roll over a retirement account inherited from their spouse into their own, thus taking the bankruptcy issue off the table.

For states that follow the federal bankruptcy laws, and Pennsylvania is one of them, this ruling also applies (a few states have their own bankruptcy laws). If you feel you need to protect your inherited retirement accounts from ending up in the coffers of your heirs creditors, then you might want to look into having a trust be the designated beneficiary of the account. Trusts, however, have their own set of problems, so this issue is one best discussed with both your financial advisor and your attorney.

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