When Does a Retirement Account stop Being a Retirement Account?

You have worked hard, and saved hard.  You have accumulated wealth in your IRA (I am using “IRA” to include all retirement plans, 401(k), 403(b)…).  And the government appreciates your efforts because it gives you protections against the claims of your creditors.  But when that IRA goes to your loved ones (called an “inherited IRA”) on your passing, those protections may longer be there.

The Supreme Court of the United States heard oral arguments on Monday (March 24, 2014) in the case of Clark v. Rameker (13-229, 03/24/2014).  And the key issue is whether a person’s inherited IRA is subject to their creditor claims in bankruptcy.  This decision can have long reaching effects on the millions of people who have billions of dollars in their retirement accounts.  And with the baby boomer generation reaching retirement age, these accounts will soon be passing to their beneficiaries in unprecedented numbers.

But the Court’s decision would not matter if there was proper estate planning done!  Proper estate planning mitigates the risks of ever changing laws and interpretations.  With the proper estate planning, a person’s IRA can be passed to the people she wants without worrying that the money they are giving will be subject to the creditors of their beneficiary.  The two main tools when planning with IRAs are the qualified trust and the IRA trust.

A qualified trust is a revocable trust that aligns with the Internal Revenue Code section 401(a), to enable the trust to be the beneficiary of an IRA, while enabling the required minimum distributions from the qualified trust to the trust beneficiary to be based on the oldest beneficiary’s life expectancy.  It is critical that this is done properly because a trust that is not qualified, and is named as a beneficiary of an IRA will force the beneficiary to deplete the IRA within five (5) years, and that is a major income tax burden!

When a qualified trust is coupled with a beneficiary trust, the decision in Clark will be moot.  A beneficiary trust, drafted in accordance to the specific state’s laws, will provide the mechanism necessary to be able to shield the inherited IRA from the reach of trust beneficiary’s creditors.

An IRA trust is a standalone trust (i.e. no other assets would be funded to it).  It combines the qualified trust and beneficiary trust, with the added benefit of being able to stretch the required minimum distribution based on each beneficiary’s own life expectancy.  So the younger beneficiaries will be able to grow more of the inherited IRA tax deferred, since the younger beneficiary will not be required to take as much of the inherited IRA’s balance out.

As the Supreme Court deliberates the Clark decision, remember that with proper IRA planning anyone could have avoided the issues that befell the Clark family.  Proper estate planning for IRAs is imperative to mitigate against the whims of Congress or the interpretations of the Supreme Court.  By using the tools of a qualified trust and/or an IRA trust will help ensure your retirement assets can be used and enjoyed by the people you have identified.

Contributed by MH Estate Planning Attorney, James P. Plitz.

What the Attorneys of Morris Hall Can Do For You:
The attorneys at Morris Hall have 100’s of years of combined experience ensuring that families’ assets are protected from probate, unnecessary taxes, creditors, ex-spouses and Medicaid spend-down.  The attorneys also help those in Arizona to apply for and receive Medicaid assistance and Veterans Benefits.  Our Arizona offices are located in Phoenix, Mesa, Scottsdale, Cave Creek, Tucson, Prescott, Flagstaff and Arrowhead.    Contact us today at 888.222.1328 to schedule an appointment!

This blog should be used for informational purposes only.  It does not create an attorney-client relationship with any reader and should not be construed as legal advice.  If you need legal advice, please contact an attorney in your community who can assess the specifics of your situation.