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Could inherited retirement accounts be lost in bankruptcy?

The U.S. Supreme Court’s decision in a bankruptcy case may have long-term implications on estate planning strategies. Essentially, the question before the court is whether a debtor who has sought bankruptcy protection and then inherits a loved one’s retirement account is compelled to turn over the proceeds from such an account to creditors.

There is a difference of opinion between federal appellate courts in regards to this question. The U.S. Court of Appeals for the Seventh Circuit held that inherited retirement accounts that are inherited do not have the same protections as the same accounts that are held by bankruptcy debtors themselves. Meanwhile, similar appeals courts in the Fifth and Eighth circuits have held that the status and protections that come with retirement accounts do not change simply because a debtor inherits them. As long as an inherited account is not disbursed, the protections remain in place.

As the U.S. Bankruptcy Code is currently construed, debtors must report inheritances received within six months of the meeting of creditors to the bankruptcy trustee. At that point, the trustee may seek to collect available funds to distribute them to creditors. This is especially important for retirement accounts that call for funds to be disbursed within a certain amount of time after the owner passes away.

With that, a comprehensive estate plan may help in protecting such assets so that beneficiaries may not be hamstrung by bankruptcy rules. Perhaps a provision to transfer retirement funds to a trust that calls for proceeds to be distributed in a way that protects beneficiaries in bankruptcy may be appropriate.

Source: “Shielding inherited IRAs from creditors,” Arden Dale, April 2, 2014