Since the bankruptcy code was amended in 2005, retirement assets such as IRAs (Independent Retirement Accounts) have for the most part been protected during bankruptcy. In other words, retirement assets aren't normally used to repay creditors in a bankruptcy case, the bankruptcy filer can keep those assets. A recent supreme court ruling has clarified the law. The supreme court unanimously decided that inherited IRAs did not fall under the category of a retirement asset. So while an IRA is protected during bankruptcy, once someone else inherits that IRA, it's free game for creditors.
What does this mean for bankruptcy filers
Those with an inherited retirement account who are considering bankruptcy need to remember this one important fact: unless they can roll (or transfer) that inherited account to an account in their own name, then those funds will be one of the first things creditors will go after during bankruptcy. However, only a spouse can inherit a retirement account and name him/herself as the owner of it. A non-spouse inheritor must leave the IRA in the original owners name.
When a spouse inherits
When someone inherits an IRA or 401K from their deceased spouse, there are a few things that person can do to make sure those assets are protected in the event of bankruptcy:
*Leave the assets in the spouse's name. Usually, this is not an option as most 401k plans require that the account be emptied within one year of the employee's death
*Roll the deceased's 401k into the spouse's 401k. If the widowed spouse has a 401k that allows rollovers from other 401ks then this option would be an effective one to protect inherited retirement assets in bankruptcy because a 401k is exempt
*Roll the deceased's 401k into an IRA in the spouse's name. If the inheritor is older than 59 ½, this option is a no-brainer as the inherited asset is now in the inheritor's name and is exempt during bankruptcy. If the inheritor is younger than 59 ½, the funds would be subject to a 10% penalty should money need to be removed from that IRA before the age of 59 ½. Even still this may be a wise move if the other two moves are not an option
When a non-spouse inherits
Because a non-spouse inheritor cannot transfer inherited retirement assets into an account in his/her name, the account must remain in the original owner's name and is designated as an inherited or beneficiary IRA. As a result, non-spouse inheritors don't have as many options for protecting inherited retirement assets. The best bet for a non-spouse inheritor is if the assets are in the form of a trust rather than an IRA. Otherwise, creditors are sure to use the recent supreme court ruling to get their hands on inherited retirement funds.
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