A recent unanimous Supreme Court ruling found that inherited IRAs are not protected under Federal bankruptcy law. This is a significant development—and not just because of the judicial unicorn of all nine justices managing to agree about something.
First a little background: In 2005, President Bush signed the bankruptcy act, which was designed to make bankruptcy less appealing. For retirees, however, it had the opposite effect by affording a certain amount of protection for retirement accounts. It gave them a cumulative $1 million inflation-adjusted bankruptcy exemption (on IRAs and Roth IRAs), a figure that is up to $1,245,000 in today’s dollars. While that money has been protected, the phrase “retirement funds” in the 2005 bill was a little too ambiguous, and, unsurprisingly, bankruptcy trustees began to challenge inherited IRAs, claiming that they are not retirement funds per se and should not be protected.
This issue has been debated back and forth over the years and different courts have reached different conclusions, but the Supreme Court ruling settles the matter once and for all. The Court’s decision seemed to revolve around one key question: is an inherited IRA truly a retirement account? The issue that seemed to be decisive and settle that question for the court was the fact that beneficiaries cannot add money to an inherited IRA.
Because inherited retirement accounts have become more common, this ruling has the potential to impact a large number of people. Two important things to note, however: spousal IRAs are still protected (and are generally rolled into the inheritor’s own IRA), and recipients of inherited IRAs who think this ruling might affect them might want to look at an IRA inheritance trust. Ask a trusted wealth management professional about your trust options.