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Are funds inherited from IRAs exempt from liquidation?

As part of the Chapter 7 bankruptcy process, the court appoints a trustee to search for assets owned by the filer that can be liquidated to pay off creditors. However, there are exemptions that often protect most — if not all — of a filer’s property.

One of the exemptions is for retirement savings. The government wants to make sure that bankruptcy filers are still allowed to save for retirement by allowing up to $1.3 million in individual retirement accounts to be exempt from bankruptcy liquidation.

However, a case that was recently heard by the U.S. Supreme Court seeks to clarify an important issue about the bankruptcy exemption for “retirement funds.” At issue in the case is whether inherited retirement funds also qualify as exempt under the U.S. Bankruptcy Code.

Lower courts have returned inconsistent answers to that question, which is why the Supreme Court decided to take it on. It is also an important issue as Americans currently have more than $5.7 trillion in retirement savings accounts, and many baby boomers will leave unspent retirement funds to beneficiaries when they die.

If the funds are left to non-spouse beneficiaries who go on to file Chapter 7 bankruptcy, the bankruptcy court needs to know whether the inherited retirement funds are subject to liquidation by the bankruptcy trustee. That is the question in the Supreme Court case.

Essentially, a Wisconsin couple filed for bankruptcy protection after their pizzeria went out of business. Years earlier, the wife had inherited $293,000 from her mother’s IRA when she passed away. The bankruptcy trustee sought to use the funds to pay off creditors, while the couple fought to save the funds.

The Supreme Court is expected to issue a decision in the case by June. We will keep you posted on the decision.

Source: blogs.wsj.com, “U.S. Supreme Court Hears Bankruptcy Fight Over Inherited IRA Money,” Katy Stech, March 25, 2014

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