The U.S. Supreme Court ruled that certain money inherited from individual retirement accounts can be taken by creditors to cover the debts of people in bankruptcy proceedings. In a unanimous ruling written by Justice Sonia Sotomayor, the court said inherited IRA money not received from a spouse isn't protected in bankruptcy proceedings.
"Nothing about the inherited IRA's legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete," Justice Sotomayor wrote.
The Supreme Court ruling applies to inherited IRAs but not to other types of retirement accounts. It also clarified instructions in the Bankruptcy Code, as millions of baby boomers begin to leave behind unspent IRA money to families and loved ones.
The Wall Street Journal article, "Supreme Court Allows Creditors to Tap Into Inherited IRA Money," notes that courts have been divided on whether money that an individual inherits from an IRA should get special protection. Bankruptcy law protects certain property that creditors would want to seize to pay debts, which can include some equity in a person's primary residence, an inexpensive car or a few hundred dollars worth of household furniture. The reasoning behind this protection is that people need a base on which to rebuild their lives once they clear their debts. These same rules permit people to keep up to $1.3 million in retirement funds they have in an IRA.
This inheritance issue came up in the case of a couple who filed for bankruptcy in 2010. They inherited $293,000 of IRA money which the wife received when her mother died in 2001. Lawyers for the couple argued the money was protected from debts that stemmed from closing their pizza shop in 2009. The bankruptcy trustee sought those funds to cover, among other things, a $74,000 judgment in favor of the restaurant's landlord.
The Wall Street Journal article stated that last year more than 45 million U.S. households had some type of retirement account and the overall value of those accounts was more than $5.7 trillion in the second quarter of 2013, according to the Investment Company Institute, a Washington, D.C.-based trade association for U.S. investment firms. The WSJ said that it was not clear how many people file for bankruptcy with inherited IRA money in their possession.
Reference: Wall Street Journal (June 12, 2014) "Supreme Court Allows Creditors to Tap Into Inherited IRA Money"