We are discussing how the Bankruptcy Code deals with individual retirement accounts. The parties are not from Illinois, but it has gone to the U.S. Supreme Court. The decision could change the law for everyone.

As we discussed in our last post, the case started when a couple filed for Chapter 7 bankruptcy. The wife had inherited money from her mother; she was named the beneficiary of her mother’s IRA. In a Chapter 7 liquidation, the bankruptcy court uses the petitioner’s assets to pay off creditors, but there are exemptions. One of those exemptions is “retirement funds.”

The couple believes the inherited money should be exempt, because it is from a retirement fund. They argue that they should be able to keep the money to make a fresh start. The bankruptcy court, however, said that the funds were the mother’s retirement fund, not the couple’s, and, so, were not exempt.

The federal bankruptcy code is not really clear about what constitutes “retirement funds,” but the code does allow a person to keep up to $1.3 million in an IRA as retirement funds. The idea is to encourage consumers to save; the code rewards planning and investing, and it allows people to hold onto enough of their property through exemptions that they can start over.

The problem with the money from the IRA in this case, the Chapter 7 trustee argued, is that the woman did not save it herself. Her mother received the protections offered by an IRA because she was setting the money aside for her own retirement, not her daughter’s. The daughter cannot contribute more money to the IRA, and the law allows her only so much time to begin to use the money. A common language understanding of the term “retirement,” the trustee said, does not match the woman’s broad definition.

But, again, the couple needed this money to make ends meet. And as we said in our last post, people file for bankruptcy for protection from creditors. They need to hold onto essentials if they are to rebuild their credit and move forward. So, if the court sides with the trustee, the couple will find themselves in greatly reduced circumstances. If the court sides with the couple, creditors may not ever be paid what’s owed to them.

We will watch for the court’s decision. June is not that far away.

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