In June 2014, a decision of the United States Supreme Court concerning inherited Individual Retirement Accounts sent repercussions through the estate planning and financial planning communities — and had a significant financial impact on a woman who inherited her mother’s substantial IRA. In a unanimous decision, the Court held that assets in an inherited IRA are subject to creditor claims in a federal bankruptcy case.
In the wake of the decision, anyone wishing to pass on assets in an IRA account to children, grandchildren, or other non-spouse beneficiaries should seek advice from a professional experienced in estate planning. In Georgia and many other states, if you use a simple beneficiary designation, the funds may lose asset protection if your beneficiary files for bankruptcy after inheriting the IRA.
Absent special treatment for those assets in your estate plan, the results can be devastating. Fortunately, advance planning with the assistance of an experienced estate planning attorney can provide asset protection for the beneficiaries of your IRA.
In 2001, Heidi Heffron-Clark inherited an IRA containing assets worth a little over $450,000 from her mother. In 2010, after a small business belonging to Heidi and her husband failed, the couple filed for Chapter 7 bankruptcy. At that time, the IRA contained about $300,000.
In the bankruptcy case, the Clarks sought to exclude the IRA assets from the pool of funds available to pay creditors. They asserted that the IRA qualified for exclusion under a retirement funds exemption in the United States Bankruptcy Code. The statutory provision enables debtors to protect funds in traditional and Roth IRAs from creditors in bankruptcy cases.
The Supreme Court determined that the retirement funds exemption in the federal law does not protect an IRA inherited by a debtor who files for bankruptcy. The Court reasoned that asset protection in bankruptcy is lost when a beneficiary inherits an IRA, because the IRA then no longer qualifies as a “retirement fund” under the Bankruptcy Code exemption.
The federal exemption remains in place for individuals who create an IRA or Roth IRA. In addition, the decision in the Clark case does not apply to a spouse who inherits an IRA. The Court’s holding applies only to a non-spouse beneficiary of an IRA.
For individuals who designate a non-spouse beneficiary for substantial assets in an IRA or Roth IRA, the holding of the Court has a significant impact. If the beneficiary is a child, grandchild, or other non-spouse, the decision means that in many cases, a bankruptcy trustee can access those assets for distribution to creditors if the beneficiary subsequently files for bankruptcy.
A small number of states adopted state-level IRA exemptions in the wake of the Clark decision. Georgia is not among those states. Debtors who file for bankruptcy in Georgia do not have a federal or state exemption to protect inherited IRA assets from creditors.
Even if an intended beneficiary lives in a jurisdiction with a state-level exemption, relying on that exemption and making that person a direct beneficiary of an IRA is risky. If the beneficiary moves to a state without the exemption, the assets likely lose protection.
An owner of an IRA can take steps to protect the inherited IRA assets as part of a sound estate plan. Protection requires creating a special type of trust, instead of naming a direct beneficiary for the IRA.
Maximizing asset protection for IRAs and retirement plans during your life requires professional advice from an experienced estate planning lawyer. The laws and rules that apply are extremely complex.
For assets in an IRA or Roth IRA, special strategies are necessary to prevent creditors of your intended beneficiaries from accessing those assets. While you probably prefer not to consider that your heir might end up filing for bankruptcy someday, anticipating that possibility — and planning for it — is the only way to protect the assets.
Instead of designating your child or grandchild as the beneficiary of your IRA, your estate plan can include a special type of trust that qualifies as a designated beneficiary for your IRA under federal tax law. This kind of trust must comply with strict laws and Internal Revenue Service rules in order to provide asset protection.
When you create a trust for your IRA assets, the trustee holds and manages the assets, distributing them to your child or grandchild (or other beneficiary) as provided in the trust document. An inherited IRA trust usually includes spendthrift provisions, which enables the trustee to preserve the assets for your child or grandchild and protect the assets against creditor claims.
Using a properly drafted trust to protect inherited IRA assets has several advantages, including:
One significant advantage of an IRA trust is that the trustee has the ability to ensure the most favorable tax treatment for assets distributed to your beneficiaries. In addition to direct beneficiary designations jeopardizing asset protection for an IRA, uninformed distribution choices by a direct beneficiary often lead to substantial taxation and loss of tax deferred or tax free growth.
If you have questions about asset protection for your IRA or other retirement accounts, our estate planning professionals at Asset Protection & Elder Law of Georgia can explain your options and help you make the right decisions for yourself and your intended beneficiaries.
Located in Cartersville, we provide estate planning services to clients throughout the communities northwest of Atlanta, including in Bartow County, Cobb County, Cherokee County, Gordon County, Floyd County and Paulding County.