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Chapter 7 and the IRA exemption: Whose retirement is it, anyway?

Bankruptcy is supposed to offer you a fresh start. The idea of bankruptcy is to clear the decks, really, to stop the collections calls and to let the bankruptcy trustee and the court deal with the creditors. In a Chapter 13 repayment plan, the debtor pays the trustee who then pays the creditors. In a Chapter 7 liquidation plan, the trustee liquidates the debtor's nonexempt assets and pays off unsecured creditors; secured creditors, say the finance company that gave the debtor his car loan, must ask the bankruptcy court for permission to repossess the collateral, in this example the car.

Bankruptcy is meant to protect the debtor, not to impoverish him. Thanks to the automatic stay and the exemptions -- which are governed by both federal and state law -- the debtor can move forward, can start to rebuild his life. So it seemed odd to a couple who had filed for Chapter 7 that the trustee would attempt to liquidate an asset that they expected to use to make ends meet.

The asset was an inheritance, but not just any inheritance: The wife was the beneficiary of her mother's IRA, and the bankruptcy code is a little hazy on how IRAs are handled. The trial court said the funds should be exempt; the 7th Circuit U.S. Court of Appeals (Illinois' circuit, though the case is not from Illinois) said the funds should not be exempt. By the end of June, the U.S. Supreme Court will make its decision.

In our next post, we will discuss each side's arguments and their different takes on what the exemption is really about.

Source: Wall Street Journal, "U.S. Supreme Court Hears Bankruptcy Fight Over Inherited IRA Money," Katy Stech, March 25, 2014

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