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Supreme Court rules some IRAs not protected in bankruptcy

Back in April, we posted about a legal challenge that had made its way to the U.S. Supreme Court. It involved a question over whether funds in certain inherited individual retirement accounts are provided protection from creditors during bankruptcy proceedings. The answer is now in.

What the high court has ruled is that some inherited IRA money doesn't constitute "retirement funds" that would be shielded under the Bankruptcy Abuse Prevention and Consumer Protection Act signed into law in 2005. 

The appearance of that two-word phrase in the law had proven to be the source of contention in many bankruptcy proceedings since BAPCPA was enacted. Split decisions from various courts on the issue did little to clear the air, so from that perspective the Supreme Court's decision is likely be welcomed by some.

The unanimous decision by the justices doesn't explicitly say so, but the thinking by many analysts is that it only applies to IRAs inherited by a beneficiary other than the spouse of the original IRA owner. That's based on the fact that the test case that triggered the ruling involves a 35-year-old woman who had inherited a $300,000 IRA from her mother.

She filed for Chapter 7 bankruptcy in 2010 and listed the IRA as an exemption, claiming it held retirement funds. But the Supreme Court ruled the term can't apply. It said that because the woman can draw on the funds any time she wants, the funds don't fit the definition as being restricted for retirement.

The implications of the ruling are not cut and dried. Analysts suggest there could be any number of possible options that might allow beneficiaries of inherited IRAs to still protect them in the event of bankruptcy. If you are in a situation where such issues are at play, you should be sure you know and understand what options exist. The best way to do that is to work with experienced legal counsel.

Source: MarketWatch, "Inherited IRAs lose bankruptcy protection," Jeffrey Levine, June 13, 2014