Are Inherited IRAs Protected in Bankruptcy?

by San Antonio Attorney

When a person files for bankruptcy, the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 provides protection to the retirement accounts and 401(k) accounts of that person.  At first, the exemption was only up to $1 million, but it was raised to $1.2 million because of increases in cost of living.

However, it had not been fixed in the federal courts whether or not IRAs that are inherited can be claimed for exemption under the BAPCPA.

The issue was resolved by the Supreme Court when it decided to accept case of Clark v.  Rameker.  The Supreme Court ruled that the inherited IRAs are not included in the retirement funds that are protected by the federal law.

The court’s underlying principle was that inherited IRA can be withdrawn any time; cannot be invested with more money by the holder; and must take necessary distributions from the IRA account regardless of how far the holder is from the age of retirement.

With that, the court ruling implies that inherited 401(k)s are not exempted as well, unless the recipient is a spouse.

There is no rule for limitations on 401(k) account balances.  The limit of $1.2 million on IRAs held by bankruptcy filers is not applicable to amounts extended from a qualified employer plan like a 401(k).  The entire amount of a participant-owned plan is totally protected by the federal law.

Inherited 401(k)s and IRAs are expected to become a more significant issue since more parents from the World War II age group — the richest bunch of senior citizens in U.S.  history — get ready for the turning over their wealth to their family members.

Based on a 2014 research, about $59 trillion — distributed among heirs, taxes, charities and others — are expected to be transferred from 93.6 million estates starting 2007 until 2061.

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