Estate Planning Pitfall: Watch out for IRA traps

Adler Pollock & Sheehan P.C.

An IRA can be a valuable estate planning tool, offering tax-deferred growth (tax-free in the case of a Roth IRA) and asset protection. But two recent developments create traps for the unwary.

The first involves the “one-rollover-per-year” rule, which allows you to withdraw IRA funds tax- and penalty-free — as often as once a year — provided you reinvest the funds in the same or another IRA within 60 days. Until recently, it was generally accepted that this limit applied separately to each of a taxpayer’s IRAs. In other words, if you had three separate IRAs, you could do as many as three 60-day rollovers per year. Even the IRS’s proposed regulations and publications say that the one-rollover-per-year rule applies on an IRA-by-IRA basis. But, in a recent decision, the U.S. Tax Court ruled that taxpayers are limited to one rollover per year in the aggregate, regardless of how many IRAs they have.

The IRS plans to follow the Tax Court’s decision and, accordingly, has withdrawn the relevant language from the proposed regs. The IRS will begin to enforce the new limit for rollovers made after Dec. 31, 2014. Keep in mind that the rule applies only to rollovers in which the taxpayer obtains control of the funds. As before, there’s no limit on trustee-to-trustee transfers between IRAs.

The second development involves inherited IRAs. Recently, the U.S. Supreme Court held that these IRAs aren’t protected from creditors in bankruptcy. Generally, this is a concern only for nonspousal beneficiaries, because spouses can obtain creditor protection by rolling over inherited IRAs into their own IRAs. But if you leave an IRA to a nonspousal beneficiary — and you’re concerned about the risk of bankruptcy — it may be preferable to establish an asset protection trust for that beneficiary and name the trust as beneficiary of the IRA.

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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