Asset Protection for Inherited IRAs

by Partridge Snow & Hahn LLP
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Owners of large retirement accounts may be lulled into complacency concerning the asset protection available to these special assets.  The funds which you (and perhaps also your employer through a matching program) have contributed to 401(K) and other retirement plans throughout your working years are afforded unique asset protection for you.  This asset protection continues even after you stop working and, most likely, have rolled over your retirement plan assets into an IRA rollover with the investment advisor of your choosing.  For married individuals, the spouse is usually named as the primary designated beneficiary of these retirement assets.  And when the account owner dies, the surviving spouse as the primary beneficiary continues to enjoy this special asset with continuing asset protection.  However, asset protection enjoyed by the surviving spouse is not afforded to other beneficiaries, including the children and grandchildren of the account owner.

Individuals who own retirement accounts and do not have a spouse or do not name their spouse as the primary beneficiary of the retirement assets may be very surprised to realize that their chosen beneficiaries will not be able to protect these important assets from creditor claims.  Illustrative of this is the recent decision rendered in June 2014 by the United States Supreme Court in Clark v. Rameker.  This case involved an IRA account inherited by the daughter of the original account owner.  In balancing the competing interests of creditors and debtors, the Supreme Court held that the asset protection afforded retirement assets was intended to protect the original account owner after retirement and enable the retiree to meet financial needs.  This special treatment can also be enjoyed by the surviving spouse of the retirement account owner.  However, the Supreme Court decided that extending this protection to anyone other than the original account owner and his or her spouse went beyond the goal of preserving funds for a retiree's financial needs. 

Because the daughter, nephew, grandchild or best friend of a retiree as the designated beneficiary of a retirement account is not afforded special asset protection, the account owner must consider whether protecting these assets from the creditors and claimants of a non-spouse beneficiary is important enough to undertake an alternative planning strategy. 

A strategy which has been available, but not frequently used, is the designation of a trust as beneficiary of the retirement account.  Properly deployed, this plan can supply the creditor protection which the original retirement account owner may desire for his or her non-spouse beneficiary.  Some retirement account owners may have been disinclined from using trusts for this purpose due to a false impression that these trusts are cumbersome and complex.  This is not necessarily so.  Though there are special technical requirements to which a trust used for this purpose must adhere, the trust is administered just like any other.  Depending on many factors, including the value of the retirement account and the general credit-worthiness of the individual beneficiary, the retirement account owner may decide that a trust is not necessary.  It is our experience, however, that a trust is often preferred.  A retirement account owner should not be deterred due to a misunderstanding of how the trust works.

The use of a trust has many applications.  Perhaps your daughter is your chosen beneficiary for your IRA rollover, but she is a surgeon and, in spite of malpractice insurance coverage, would generally be more prone to claims of creditors than if your daughter was a kindergarten teacher.  However, regardless of your daughter's chosen career and how you feel that career may impact your daughter's ability to protect and preserve assets for herself and her family, the value of the IRA may be so significant that you would prefer to protect your daughter – the surgeon as well as the kindergarten teacher – rather than risk your hard-earned retirement assets to any potential third-party claimant.  Even your daughter the kindergarten teacher could be in a car accident and be responsible for another person's injuries thereby triggering litigation and potential liability to the injured person and exposing the retirement assets which your daughter inherited from you to her claimant.  Furthermore, not all beneficiaries need be treated the same.  Perhaps one child should inherit a share of your IRA rollover directly, but another child’s share should be held in trust.

Being aware of this recent United States Supreme Court decision and how it impacts inherited retirement accounts is a first step.  Becoming accurately informed about the mechanics of an estate plan which includes naming a trust as the beneficiary of your retirement account to supply creditor protection is a very important second step.  Only with correct information can you make the best decision concerning your wealth preservation strategy. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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