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July 28, 2014

Inherited IRAs Can Be Reached by Creditors to Pay Debts

According to Wisconsin bankruptcy judges, the money in inherited individual retirement accounts is subject to collection by creditors and not protected by Wisconsin or federal exemption laws.

Federal bankruptcy laws and state law permit individuals to claim certain property as exempt from the reach of their creditors.  Many types of retirement accounts and benefits are protected by these exemptions. In his May 10, 2011 decision in In re Clark, Case No. 10-18035, Bankruptcy Judge Robert D. Martin concluded that an inherited individual retirement account can be reached by the heir’s creditors, and that neither federal nor state exemptions protect the monies in an inherited IRA.

Under federal bankruptcy law, for a retirement account to be safe from creditors, (1) the monies must be “retirement funds” and (2) those retirement funds must be in an account exempt from taxation under one of various provisions of the Internal Revenue Code. Judge Martin concluded that the monies in an inherited IRA are not “retirement funds” to the person who inherited them, and are not exempt from taxation under any of the applicable Internal Revenue Code provisions. 

Under state law in Wisconsin, certain accounts or amounts payable under pension, IRA and other accounts and plans or contracts “providing benefits by reason of age, illness, disability, death or length of service” and in compliance with provisions of the Internal Revenue Code for retirement accounts are safe from creditors. Judge Martin agreed with his colleague, Judge Susan Kelley, and her decision in In re Kirchen, 344 B.R. 908 (Bankr. E.D. Wis. 2006), that an inherited IRA is not a “retirement benefit,” the funds are not payable on account of the heir’s age, illness, disability, death or length of service, and that such accounts do not comply with the Internal Revenue Code provisions for retirement accounts.

Courts in other states have protected inherited IRAs from creditors’ reach under their state laws, and have disagreed with the Wisconsin bankruptcy court judges on the protection offered on such accounts under federal bankruptcy law. 

© MICHAEL BEST & FRIEDRICH LLP

About the Author

Ann Ustad Smith Attorney Michael Best Friedrich LLP
Partner

Ann Smith practices in the areas of bankruptcy, commercial litigation (primarily related to lending, fraud and contract disputes), commercial transactions (including financings, asset sales, liquidations and related matters, especially involving distressed businesses) and constitutional litigation. She is regularly involved in workouts, foreclosures (including receiverships and emergency orders), replevins, bankruptcy proceedings (including motions for relief from stay, cash collateral and adequate protection matters, Chapter 11 plan confirmation matters and purchase of assets out of...

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