Estate and Gift Tax – Is your IRA Protected from Creditors?
When we talk about Estate and Gift Tax and the world of asset protection, it has long been believed that retirement accounts, including Individual Retirement Accounts (IRAs), are not subject to the claims of creditors. However, a recent ruling by the U.S. Supreme Court has turned that belief on its head, and you may need to do further planning.
The Court case is Clark v Rameker and it applies to Inherited IRAs. Let’s say that you inherited an IRA account from your father. If you were to invest well and take only the required minimum distributions from the account, this inherited IRA could last for another 20-30 years, and thus provide additional retirement planning for you.
In spite of those facts, however, you are not able to make additional contributions to an inherited IRA and you can withdraw funds from the inherited IRA without tax penalty. Therefore, the Supreme Court says that the inherited IRA is not really a retirement account, and not protected as an exempt asset under bankruptcy laws. If you can have access to those funds whenever you like, then your creditors should be able to have the same access.
It seems that retirement planning and saving in general is under attack. After decades of incentivizing (through tax deferrals) retirement savings through 401ks, IRAs, and other retirement plans, members of Congress have recently made proposals to end the “stretch” payout provisions of retirement plans and cap the value of IRAs. So, the decision by the Supreme Court, that an inherited IRA is not really a retirement account, is not totally surprising.
States are still able to create their own bankruptcy exemptions that are not preempted by federal law. Several states have already passed laws protecting inherited IRAs in bankruptcy cases, and other states may follow. But what can you do if you want to leave your IRA to your heirs?
For many people, an IRA or other retirement account is their largest asset, and most of us would prefer to pass an inheritance to our loved ones protected from their creditors. If you’re married, a spousal rollover of your IRA is still protected. You should, of course, check with your professional advisors for your specific situation. However, it may turn out that the ideal solution to avoid the inherited IRA problem on the death of the second spouse is to name a trust, not an individual, as the designated beneficiary of your IRA. Proper trust planning can actually circumvent the Clark v Rameker decision.
These IRA beneficiary trusts are often called “look through trusts” because, for administrative purposes, the IRS looks through the trust to the individual beneficiary. As such, these trusts can take advantage of the “stretch out” provisions mentioned above that allow minimal distributions, and decades of tax-deferred appreciation for the beneficiary.
Trusts are useful for creditor protection because they typically have provisions built in that require the trustee to manage the trust for the benefit of the beneficiary, and disallow the payment of trust assets to creditors. Again, check with your professional advisor to see what is best for your specific situation.