Bankruptcy and IRAs

The federal bankruptcy exemption for IRAs was originally set at $1 million through the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Every three years, that amount is adjusted for consumer price index changes. The federal IRA bankruptcy exemption limit is currently just over $1.2 million.

IRAs created under an employer sponsored section 408(k) simplified employee pension (a “SEP IRA”) or a section 408(p) simple retirement account (a “SIMPLE IRA”), as well as pension, profit-sharing, or section 401(k) wealth transferred to a rollover IRA, enjoy an unlimited exemption from the bankruptcy estate.

The big question is, what happens if you inherit an IRA and have filed for bankruptcy? Will your inherited IRA be protected from creditors? The short answer is, maybe.

Lower courts have disagreed on whether inherited IRAs enjoy the same protection. There is a basic conflict among the courts as to whether inherited retirement assets retain their “retirement funds” status for purposes of bankruptcy creditor protection for the beneficiary after the original owner is out of the picture.

This year, the U.S. Supreme Court will address this issue to try and resolve the conflict in lower courts over whether assets in an inherited IRA meet the standard of “retirement funds” for purposes of creditor protection in an IRA beneficiary’s bankruptcy proceeding. The case, In re Brandon C. Clark, was granted certiorari, meaning the Supreme Court will re-examine the case and make a final decision.

Regardless of the Court’s decision, this is a very important case for IRA owners and IRA beneficiaries to follow, as this decision could change their IRA distribution strategies.

*Note: Federal IRA bankruptcy protection does not extend to other creditor protection cases; non-bankruptcy creditor protection limits are governed by state law.