Regular IRAs vs. Inherited IRAs

According to the Supreme Court, in a recent case involving the Bankruptcy Code’s exemption for retirement funds, a retirement account is not a retirement account if it is an inherited IRA and the owner is bankrupt.

Typically, when a person files for bankruptcy, funds they set aside for retirement can be exempt from the estate. When the bankruptcy case is settled, those funds will be available to the individual to use during retirement. However, the exemption is for retirement funds that are in an account that is tax-exempt under sections of the IRS code.

The Supreme Court determined that an inherited IRA does not consist of retirement funds, so it is unnecessary to figure out if it was held in the right type of account. Unlike a typical IRA, where funds cannot be withdrawn until a certain age without penalty, funds in an inherited IRA can be withdrawn without penalty at any time. In fact, most funds in an inherited IRA are usually required to be withdrawn by the required minimum distribution rules.

The court stated that retirement funds are a way to preserve a debtor’s ability to meet the basic needs of life without dealing with a cash windfall at the expense of creditors. Inherited IRA’s legal characteristics have nothing to do with preventing or even discouraging the use of the entire balance to purchase luxury items following the bankruptcy proceedings.

After discussing whether or not to apply the exemption, the court affirmed inherited IRAs are not retirement funds and not eligible for exclusion from debtor’s bankruptcy estates.

If you have any questions about IRAs or inherited IRAs, contact the skilled accountants and tax experts at Staszak & Company.