On June 12, 2014, the U.S. Supreme Court ruled that an inherited IRA is not an asset protected retirement account. This decision has far-reaching implications.
U.S. Supreme Court Justice Sotomayor wrote that Heidi Heffron – Clark who inherited an IRA from her mother in 2001 and later filed for bankruptcy in 2010 was unable to shield her inherited IRA account from her creditors. Clark v. Rameker.
In basic terms, the distinction that the court made was between an inherited IRA and an IRA that was set up and funded by an individual who made the money during her lifetime. There are many protections that are afforded to an IRA owner that is the original owner from creditors and bankruptcy. There fore, the Supreme Court ruled inherited IRAs are not protected as retirement accounts. However, the Court reasoned that unlike the original owner, the inherited IRA recipient may withdraw money from the account without penalty at any time.
Therefore, this makes the account different from the rules that govern the original owner of the IRA. Additionally, the inherited IRA owner may not add additional funds to the inherited IRA. Further, the court said that the entire account balance must be either withdrawn within five years of the original owner’s death or a required minimum distribution must be taken each year starting by December 31st in the year following the original owner’s death through a stretch out based on the inherited IRA owner’s life expectancy. The court found that these distinctions made the inherited IRA much less restrictive to the person inheriting it, and therefore should be subject to her creditors.
There are however ways around this devastating result. One such strategy is to create a Retirement Plan Trust as the designated beneficiary of the IRA. This is a specialty trust used by savvy estate planning attorneys that can provide asset protection to the beneficiary of the inherited IRA. For example, in this case, if Heidi Heffron – Clark’s mother had set up a properly structured Retirement Plan Trust, which listed her daughter as the beneficiary of that trust, she could have protected the IRA from Heidi’s creditors.
Basically, how this strategy works is that if an independent trustee governs the Retirement Plan Trust after the death of the original owner, the IRA can be stretched and a required minimum distribution can funnel into the trust at least annually. Then, the required minimum distribution can flow to a continuing trust inside the Retirement Plan Trust in which the independent trustee can shield from a creditor.
The key here in the Retirement Plan Trust is to make sure that the beneficiary has no demand right against the trustee and that there’s an independent trustee in place when a claim is made against the trust. Even when we have an interested trustee to start with, which means somebody that’s either acting as their own trustee or that the trustee is closely related to the beneficiary, we can have that interested trustee resign at the first sign of trouble and appoint an independent trustee to take over.
Note however, the safest thing to do is to appoint an independent trustee from the get-go. For more information on the Hefferon – Clark case in layman’s terms, visit http://tinyurl.com/q49jvn2.
To learn more about Retirement Plan Trusts, call our office at (760) 448–2220 or contact Lisa Logee at [email protected].com to obtain a free copy of my new book “Secrets of Great Estate Planning” and an advance chapter from my new upcoming book on advanced estate planning strategies I’m writing with the distinguished Pennsylvania attorney David Frees.