Saturday, March 13, 2010

INHERITED IRA DOES NOT RECEIVE FEDERAL BANKRUPTCY PROTECTION

A Bankruptcy Court in Texas has ruled that unlike a traditional individual retirement account (IRA), an inherited IRA is not an exempt asset in bankruptcy under federal bankruptcy exemptions. The basis of the ruling is two-fold.

First, to be exempt, the funds in the IRA must be “retirement funds.” While the funds would be retirement funds as to the original IRA participant, they are not for someone who inherits the account.

Second, the Bankruptcy Code requires that the funds be exempt from taxation under Internal Revenue Code Section 408. Since inherited IRAs are created and treated under Code Section 402(c)(11), the Code Section 408 requirement was found not to be met.

It is likely that inherited qualified plan assets would be similarly treated as inherited IRA’s.

States are allowed to allow debtors to use state law exemptions in bankruptcy instead of federal exemptions. However, some states have similar issues as to inherited IRAs. For example, as you may recall, a recent Florida case held that Florida’s state law IRA exemption also does not apply to inherited IRAs. Robertson v. Deeb and RBC Wealth Management, 2nd DCA, Case No. 2D08-6428 (August 14, 2009), as discussed in the October 21, 2009 entry to this blog.

In re Chilton, (Bktcy Ct TX 3/5/2010) 105  AFTR 2d ¶ 2010-575

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