Are Inherited IRAs Exempt From Creditors? Well, It Depends

Does an Inherited IRA maintain its original exemption from creditor's claims?

Under Chapter 7 of the Bankruptcy Code, funds that are set aside for retirement are protected from creditors’ claims to satisfy pre-retirement debts. However, when the owner of the IRA dies, whether the exemption continues will depend upon where the beneficiary resides and what relationship the beneficiary had to the owner of the IRA.

There is no question that a spouse who inherits an IRA from his/her deceased spouse continues to enjoy the original exemption from creditor's claims. However, if a child or unrelated person is the inheritor, then if the inheritor resides within the territory covered by the Seventh Circuit of the United States Court of Appeals, the exemption is not available, according to a recent decision by the Seventh Circuit Court of Appeals.

According to the Court, since the non-spousal inheritor of the IRA account must withdraw the funds within five years from the death of the original owner, it is no longer a “retirement” account and the beneficiary no longer has the benefit of the exemption. The decision of the Seventh Circuit is in conflict with the decisions of two other federal circuit courts of appeal; namely the Fifth and Eighth Circuits, each of which has held that the exemption from creditors continues while the funds remain in the IRA.

By reason of the conflicting positions of the Fifth, Eighth and Seventh Circuit Courts of Appeal, this issue may ultimately be decided by the Supreme Court. In the meantime, "location, location, location" is the determining factor.

From the Author: Alan E. Sohn