One of the key questions in a bankruptcy proceeding is exempt vs. non-exempt assets. And one of issues that can come up there is whether individual retirement accounts that someone has inherited should be considered exempt assets — and therefore beyond the reach of someone’s bankruptcy creditors.
Federal courts have not agreed on how this question should be settled. This issue affects people in the San Antonio area and across the country in cases where someone is trying to protect from creditors the proceeds they have inherited from a retirement account.
The most recent court ruling on the question came last week. The Seventh Circuit Court of Appeals held that such proceeds are not exempt assets and can therefore be reached by bankruptcy creditors. But other federal courts have reached the opposite conclusion.
Analytically, the important question is the status of the proceeds of a 401(k), IRA or other retirement account when it passes through inheritance. If the status is considered to be cash, then the argument for allowing creditors to reach it becomes stronger.
From a public policy standpoint, however, it is hard to see how allowing creditors to reach inherited retirement accounts can be beneficial. After all, it is in society’s interest to encourage people to save for retirement. Indeed, that is surely the rationale for allowing the bankruptcy law exemption for retirement accounts in the first place.
To be sure, that rationale is not as strong when someone withdraws money from the account or does not invest it again for retirement after inheriting it.
In any case, the issue in cases of this type is the same regardless of the type of consumer bankruptcy involved. Regardless of whether it’s a Chapter 7, Chapter 11 or Chapter 13, the question of whether creditors can reach the proceeds of inherited retirement accounts in a bankruptcy depends on how those accounts are characterized.
Please visit our page on consumer bankruptcy.
Source: Source: “In circuit split, court says inherited IRS fair game in bankruptcy,” Thomson Reuters News & Insight,” Nick Brown, 4-24-13