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Could you lose inherited IRAs in bankruptcy?

If you are in the midst of a bankruptcy and you inherit funds from a retirement account, those funds could be the property of the bankruptcy estate; meaning that they may be used to pay off creditors and essentially lost, according to a U.S. Supreme Court ruling earlier this year.

The high court ruled unanimously that inherited IRAs are fair game for creditors in bankruptcy proceedings. The ruling abated confusion among appellate courts as to whether such assets could be part of the estate, especially given that people who inherit such funds may not be able to access them until they reach retirement age without incurring significant penalties. 

Justice Sonia Sotomayor, writing for the court, reasoned that because money from an inherited could be withdrawn without the need for the new owner to retire, these funds are inherently different from other retirement accounts that are protected by federal law.

Because of this distinction, Sotomayor wrote, someone who goes through a bankruptcy could use the newly found proceeds on a vacation home or a sports car directly after the proceedings have ended, thus thwarting the purpose of bankruptcy altogether. Under the U.S. Bankruptcy Code, debtors must report any inheritances they receive within six months of the meeting of creditors to the bankruptcy trustee.

As such, changing how you may leave retirement accounts to heirs may help in avoiding this situation; thus protecting your assets for future use. Perhaps creating a trust with specific terms about disbursements may be best. If you have questions about trusts and how they work, an experienced estate planning attorney can help. 

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