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PROTECT THE UNPROTECTED: INHERITED IRA ASSETS

The U.S. Supreme Court recently unanimously ruled in Clark v. Rameker that an inherited IRA is not an exempt asset in bankruptcy. An “inherited IRA” is an IRA that is left to a beneficiary after the owner's death. An “exempt asset” is an asset that a debtor is allowed to keep irrespective of the bankruptcy proceeding.

This case involved a mother’s IRA that named her daughter as the beneficiary. The mother died in 2001 and the daughter filed for bankruptcy in 2010. The Supreme Court ruled that the inherited IRA would not be exempt from the daughter’s creditors in the bankruptcy proceedings because they were not considered exempt “retirement funds” to the daughter (they were the mother’s “retirement funds”). The logic of this case would also seem to apply to an inherited 401(k) or 403(b) account.

If the mother had named an IRA Trust as the beneficiary, the mother’s IRA would have been excluded from the daughter’s bankruptcy estate. This is not the only asset protection advantage to creating an IRA “stand-alone trust.” If the IRA Trust is an “accumulation trust,” IRA distributions can be kept in the trust and protected from frivolous spending by the beneficiary, lawsuits against the beneficiary, and other creditors of the beneficiary (which could include a soon-to-be ex-spouse).

Naming a separate stand-alone IRA Trust as the beneficiary of your IRA can also preserve important tax benefits. If the IRA Trust qualifies as a “designated beneficiary” under IRS rules, mandatory distributions to the beneficiaries (under applicable IRA rules) can be spread out over the life expectancy of the oldest beneficiary, thereby deferring any income taxation on those assets. Otherwise, distributions from the IRA must be made (i) over five (5) years if the participant died before the “required beginning date” for distributions (i.e., the year after the participant reached age 70 ½) or (ii) over the original owner’s life expectancy if he or she died after the required beginning date.

If you have a large IRA, consideration should be given to naming an IRA Trust as its beneficiary after your death. The terms of the IRA Trust should be designed to fit your particular objectives. A custom trust should also be considered as the beneficiary of your 401(k) or 403(b) account.

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Barry S. Engel
Email: info@engelreiman.com