Protecting IRA Assets For Your Heirs

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Due to a recent Supreme Court decision, you may need to take extra steps to protect IRA assets you leave your heirs.

Supreme Court cases may not be on your “must read” list, but there is one recent decision you should be aware of.

The country’s highest court just ruled that inherited IRAs, or IRAs you leave to your beneficiaries, are NOT protected from creditors.

“The U.S. Supreme Court recently (and unanimously) ruled that funds held in an inherited IRA are not exempt from creditors in a bankruptcy proceeding because they are not really retirement funds. Clark v. Rameker (U.S., No. 13-299, June 13, 2014),” reports an elder law online source.

What exactly does this mean?

Let’s say you name your child as the beneficiary of your IRA. After your death, your child receives the assets of that IRA in an account now called an “inherited IRA” because she inherited it from you.

Your traditional and Roth IRAs up to $1.245 million (more in some states) are already protected from creditors under federal and state bankruptcy laws. “But several state courts have ruled that inherited IRAs do not qualify as retirement plans,” writes the Wall Street Journal. Now, the Supreme Court has agreed.

The Supreme Court ruling says that if those children subsequently declare bankruptcy, they could lose the inherited IRA funds. Unlike regular IRA accounts, which are retirement accounts and are protected, inherited IRAs were found not to be true retirement accounts, and are therefore not protected from creditor claims.

But what about Florida law?

Good question.  Elder law attorney Joseph Karp reminds us in his blog that “Florida statutes exempt inherited IRAs from creditor claims.” That means IRA assets you leave to heirs are protected under Florida law.

But there is still a problem, says Karp.

“The problem is that there are two different and distinct issues at play. One, can a creditor attach a Florida resident’s inherited IRA? Clearly, no. Two, can a debtor who resides in Florida be discharged in bankruptcy while retaining an inherited IRA? The latter has yet to be answered by our courts.”

So while your Florida beneficiary cannot have the IRA taken away to satisfy creditors, your Florida beneficiary may not be able to protect other assets through the bankruptcy process and have debts discharged without surrendering the inherited IRA. Since this decision was just handed down by the Court, no one knows how this will all play out.

The dilemma

If your heirs live in Florida, it’s easier. But if your heirs live elsewhere (or move elsewhere), you may need to take additional steps to protect your IRA legacy, especially if you feel your beneficiaries already have debt, legal, or career issues, that may put them at greater risk.

The solution?

Your estate planning attorney can help you evaluate the risks and find ways to protect assets for your heirs, as needed.

One option may be to leave the IRAs to a trust that protects beneficiaries.

“If you intend to leave your IRA to your children, you should take steps without delay to protect the funds from your child’s creditors in the event your child goes through a bankruptcy in the future,” warns attorney Karp. His advice is to not make your child the beneficiary of your IRA. Instead, he says, “leave it in a spendthrift trust for your child. A properly drafted IRA Trust or IRA Stretchout Trust can accomplish this goal. Do not rely on a traditional revocable living trust to accomplish that goal.”

The takeaway:  We understand the last thing any client wants to hear is that they need more complex and expensive solutions to meet their estate planning goals. But this Supreme Court decision does throw a wrench in some of the previously best-laid plans.

The situation is still shaking out, but do realize your estate plans may need to be updated to protect your heirs as a result of this high court decision. So pencil in a date to talk to your attorney to seek his or her advice on whether your plans need updating.

 

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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