You can’t do that with an IRA

In general, funds in an IRA are protected from creditor claims in bankruptcy. However, the protection does not apply to an inherited IRA, the U.S. Supreme Court has ruled. Funds in an inherited IRA may be withdrawn at any time without penalty, assets generally must be distributed within ten years, and contributions to inherited IRAs are prohibited. Given these characteristics, an inherited IRA is not “retirement funds” within the meaning of the bankruptcy code.

Stephanie inherited a $44,000 IRA from her father when he died. A few years later she withdrew the entire amount and contributed it to a new IRA in her own name. After that she used the money to purchase an individual retirement annuity.

Before the Bankruptcy Court Stephanie argued that because the IRA had become her own, it should be a protected asset, immune from creditor claims. It was no longer an inherited asset. Unfortunately, the Court pointed out, in the year that Stephanie moved the money the limit on IRA contributions was $6,500 ($5,500 plus a $1,000 “catch-up” contribution). Stephanie had made a substantial excess IRA contribution. As such, she was required to pay a penalty tax and file additional IRS forms until the excess contribution was corrected. As Stephanie had done none of these things, the Court held that the IRA was not a tax-exempt account to any degree, and was fully vulnerable in bankruptcy.

IRAs and inheritances can be complicated assets to manage for those who lack familiarity with all the requirements. Professional advice is generally a very good idea in these situations.

You Can't Do That with an IRA

An inherited IRA is not "retirement funds" within the meaning of the bankruptcy code.

You can’t do that with an IRA