February 20, 2015
In the second of a two-part series on the estate planning trends for 2015, we are addressing the increased use of trusts for inherited IRAs.
An Inherited IRA is Different Than a Spousal Roll-Over IRA
When a spouse inherits an IRA from a deceased husband or wife, the surviving spouse can “rollover” the IRA as a Spousal Rollover IRA. To be clear the Spousal Rollover IRA is different than an Inherited IRA. An Inherited IRA is where a non-spouse, such as a child, is named as the beneficiary of an IRA. When the non-spouse receives an IRA following the death of the IRA owner, this is referred to as an Inherited IRA.
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Historic Use of Trusts for IRA Distributions Following Death Infrequent
The Inherited IRA beneficiary can usually elect to receive the IRA proceeds as a lump sum or can elect to “stretch” the IRA payments out over a longer time period. Sometimes the Inherited IRA beneficiary can even elect to stretch these IRA payments over his or her life expectancy, thereby creating funds for his or her retirement.
Historically speaking, the non-spouse beneficiary could often reduce his or her income taxes paid on the IRA by stretching the Inherited IRA payment over a longer time period. Moreover, most creditors and courts had treated the Inherited IRA as safe from creditors.
In the past, unless there was a valid reason to plan otherwise, most clients preferred to name their adult children directly as beneficiaries on their IRAs. This allowed the children to decide how quickly to access the funds, without the inconvenience of having the IRA flow through a trust. We anticipate, based upon our research, conversations with other financial professionals and discussions with clients, that most of our clients will still choose to name beneficiaries directly on their IRAs.
However, in light of a recent United States Supreme Court decision, Clark v. Rameker, we will be discussing the advantages of naming inherited IRA beneficiaries not directly, but through an “Inherited IRA Trust,” which is also referred to as a “Retirement Trust.”
What Exactly Did Clark v. Rameker Hold?
In Clark v. Rameker, a mother named her daughter as the beneficiary on an IRA. The daughter established an Inherited IRA and chose to take payments from the IRA over time, i.e., not all at once. So, in this case, the daughter had an “Inherited IRA.”
In the past, the courts generally treated an Inherited IRA as safe from one’s creditors. And, it is still true that an IRA that one establishes and funds with his or her own earnings still has certain creditor protection.
However, in Clark v. Rameker, since the daughter did not establish and fund the IRA with her own money, but rather inherited the IRA as a beneficiary, the Court held that the daughter’s Inherited IRA was not a “retirement fund.” Therefore, the Supreme Court reasoned that the daughter’s Inherited IRA was not protected from creditor claims or bankruptcy.
As this is a United States Supreme Court decision, it is considered the law of the land and other courts will follow this reasoning and no longer consider Inherited IRAs as protected from creditors and certainly not protected in federal bankruptcy proceedings.
How Can You Protect Your Inherited IRA from Children’s or Other Beneficiary’s Creditors?
Due to the Clark v. Rameker decision, we will recommend — or at a minimum discuss — the advantage of creating an Inherited IRA Trust to administer a child’s or other non-spouse beneficiary’s proceeds from an IRA.
In order to protect the Inherited IRA from the beneficiary’s creditors, the Inherited IRA can be paid to a specially drafted “Inherited IRA Trust” that is considered a “see-through” trust for tax purposes. This type of trust can provide creditor protection for the non-spouse beneficiary, stretch out the IRA payments for the beneficiary to reduce the tax burden, and prevent the beneficiary from withdrawing the full balance all at once.
If you have significant IRA assets for which you want enhanced creditor protection for your non-spouse beneficiaries, it is important to discuss the advantages and disadvantages of the use of a properly drafted Inherited IRA Trust.
Please contact us on 262-658-2181 or via email at info@wokwicz.com if you would like to set up an appointment to discuss if an Inherited IRA Trust is appropriate for your situation.
Did you miss the first article in our series on estate planning trends for 2015? Here is it: Advanced Care Planning