Court Challenges Exemption of Inherited IRAs

Most people, including myself, understood that all IRAs were exempt from creditors outside of bankruptcy and were exempt from the bankruptcy estate for debtors who filed bankruptcy. I received an email from attorney Tye Klooster about an Illinois bankruptcy case which holds that some IRAs are not exempt. If followed in Florida bankruptcy courts this ruling would diminish IRA protection for Florida residents

Illinois, like Florida, has state statutes which exempt IRAs from creditor collection process. The Illinois statute and the Florida statute protect IRAs that are "exempt from taxation" under Section 408 of the Internal Revenue Code. This Illinois bankruptcy judge said that IRAs which a beneficiary inherits after the death of the owner are not exempt from taxation because the inherited beneficiary is not able to make tax deferred contributions to the IRA and cannot roll over the IRA tax free to a subsequent beneficiary. The judge concluded that inherited IRAs are not within the class of IRAs protected by the Illinois statute or the bankruptcy law.

If this reasoning is followed by Florida courts it could significantly impact asset protection planning for Florida residents in or out of bankruptcy.

The case is In re Taylor, decided May 9, 2006, in the central district of Illinois. Bankruptcy Case No. 05-93559