Protecting your IRA from Creditors and Preditors After the Supreme Court Decision

The U.S. Supreme Court recently held that the funds contained in an IRA are not “retirement funds” and thus not protected from creditors during bankruptcy. The next question many attorneys now have is how this ruling will affect tax law?

The Supreme Court justices felt there were three legal characteristics that lead the Court to conclude inherited IRA’s are not retirement funds within the meaning of 11 U.S.C. Section 522(b)(3)(c).

  1. Inherited IRA holders are not able to invest more money into the account.
  2. The law requires the holder to withdraw funds from an inherited IRA no matter how far from retirement the holder may be.
  3. The holder is able to withdraw 100 percent of an inherited IRA’s funds without penalty.

Before this case, IRAs and inherited IRAs were believed by some to be protected from creditors. It now appears that for inherited IRAs this is not the case. While Florida residents have protection for Inherited IRAs, where the Florida law applies, we do not know where our beneficiaries will live or what type of trouble they may create in the future. Those who inherit IRAs may now need to take extra precautions to avoid the risk of loss of their IRA.

When a spouse inherits an IRA he or she has three options. The spouse can inherit the IRA, create a new IRA, or roll the inherited IRA into an existing IRA. We do not recommend that the Spouse inherit the IRA as would make the IRS subject to risks of creditors. A spouse should generally choose to create a new IRA or roll the IRA over into an existing IRA.

Another way to reduce taxes or extend the life of an IRA is to convey the IRA to the children instead of the spouse. Naming a trust as the beneficiary can provide this option in the future as it is often difficult to know if there will be enough money for the surviving spouse. The trust should have separate retirement account language so that the trust will be a “see through” trust and not require a 5 year payout of the funds.

There are four steps required for the IRS to find a trust to be a “see through” trust.

  1. the trust must be irrevocable at death.
  2. the trust must comply with the state law of where the trust is located.
  3. the trust’s beneficiaries must be human.
  4. a copy of the trust must be provided to the IRA custodian by a certain date.

As far as providing a copy of the trust say this must be done prior to death and others state it must be done no later than 9 months after death. We recommend that a copy be given to the custodian prior to death.

The next issue comes from what beneficiary must be named in the trust. Remember the same rules regarding naming of the beneficiaries should be followed as if the IRA was left to a beneficiary.

It is also important to determine how the trust will pay the beneficiaries. This is done through either an accumulation or a conduit trust. An accumulation trust allows a trustee to hold the funds and not distribute them. This is usually done to protect the money from judgments and creditors. However, an accumulation can be taxed at the highest tax rate after only $12000 in income. If there is a creditor who would take the IRA payments, then paying a higher tax rate is not a bad option compared to loosing the entire amount. A conduit trust is used to make regular payments to beneficiaries for the remainder of the projected life or the life of the oldest person to receive a portion of the IRA. If there are people with large differences in their ages as beneficiaries, it is possible to split the IRAs so that each person has their own life expectancy to calculate their IRA payments over. Many planners do not give the option of using an accumulation trust, but giving our clients the extra flexibility can be a good option. Remember as estate planners we try to plan for unexpected events and offer options for them when they do happen.

Planning how to protect your IRA or retirement accounts from the potential creditors of your heirs is a fairly complicated process that should be reviewed by an attorney who is familiar with these issues. For more information regarding inherited IRAs, contact David Goldman at 904-685-1200.

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