Lost Asset Protection for Inherited Retirement Accounts? The US Supreme Court’s Recent Ruling

From the Desk of San Diego Will and Trust Attorney, Kristina R. Hess

Retirement Account Asset Protection Lost?

The Supreme Court’s Recent Ruling On Inherited IRAs

Until recently, IRAs or other qualified retirement accounts were a great way to build wealth in a tax-deferred and asset protected manner.  Many people had a sense of security knowing that these assets were protected from creditors when passed down through generations in a secured account.  A recent Supreme Court case has broken this shield.  Now, inherited IRAs and potentially other retirement accounts will not be protected from creditors and potentially other outsiders.

How Inherited IRAs work.  If Sally Smith of Solana Beach inherits an IRA when her mother dies, as the beneficiary of an inherited IRA or retirement account, she would take the required minimum distributions each year and pay income taxes on these distributions.  The distributions must start the year following the death of the owner, her mother (not at retirement age).  However, Sally could  “stretch” the distributions over her life expectancy.  If Sally “missed” the stretch (and withdrew more than the RMD or failed to elect the stretch) then, she would have to withdraw the entire account within five years.   She would lose the ability of the account to compound and grow tax deferred.

Before the Clark v. Rameker  ruling, the balance of the retirement account would remain secure in the account until withdrawn at a later date.  Inherited IRA accounts were considered “retirement accounts,” even when inherited and distributed during non-retirement periods.  As such, creditors were unable to reach these assets during collection or bankruptcy proceedings.

The Supreme Court ruled on June 12th, 2014, in the Clark v. Rameker case, that Inherited IRAs are not retirement accounts for the purpose of shielding assets from creditors or during bankruptcy.  Thus, if a child or other non-spouse beneficiary inherits a retirement account directly, this asset is not protected from creditors.  A surviving spouse on the other hand, will maintain creditor protection if he or she rolls over the IRA into her own IRA, as the assets will remain “retirement funds.”

How does this affect your estate plan?  If one of your goals is to provide your beneficiaries with asset protection, then an IRA account owner may consider designating a trust as the IRA beneficiary as opposed to a non-spousal heir.   There may, however, be income tax consequences to consider.  Irrevocable trusts with income over $12,150 (in 2014) are taxed at the highest bracket (39.6%).  Conduit trust provisions, allowing the trustee to pass through the required minimum distributions to the beneficiaries, are more advantageous from an income tax perspective.  Yet, once the assets leave the trust they are not protected.  Moreover, it is unsettled legally whether doing this would eradicate any asset protection of the accounts.

IRA account owners should speak with an attorney regarding the pros and cons of the various options in light of this new ruling.  Naming a trust as a beneficiary could be a useful strategy for asset protection.  It is important that the trust contain the appropriate provisions to accomplish your goals.

KR Hess Law, P.C., takes pride in staying up to date with current laws affecting all aspects of estate planning. It is our mission to equip people with the tools necessary to create legacies that last, empower the generations, and inspire generosity.