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A Better Partnership


Jul 2014
July 01, 2014

Estate Planning Tip: Inherited IRAs are not entitled to protections from creditors

The U.S. Supreme Court recently decided in Clark v. Rameker that inherited IRAs are not retirement funds for purposes of the federal bankruptcy statute.  The effect of this decision is that IRA funds that an individual leaves to children or other heirs are not protected from creditors.  There is no restriction on creditors attaching such accounts.
Leaving IRAs to Trusts

Because of this, individuals have another reason to leave IRAs to their heirs through trusts.  Many financial advisors tell their clients not to leave IRA assets to a trust because they have heard that there are adverse tax consequences to doing so, i.e. that the heirs may not spread out distributions from the IRA over the heir’s life expectancy.  However, a well-designed trust does allow an heir to stretch distributions over his or her life expectancy.  There are two types of trusts that are used to receive retirement account distributions that do not have adverse tax consequences.  The first, a “conduit trust,” requires the distribution of all minimum required distributions to the individual beneficiary.  This is not ideal for asset protection planning.  Because the distribution is required, a creditor may simply grab each minimum required distribution as it becomes due to the beneficiary.  An “accumulation trust” allows a trustee to accumulate distributions from the IRA or use them for the benefit of the beneficiary without direct distribution.  This type of trust provides strong asset protection while allowing the IRA distributions to be stretched over the beneficiary’s life expectancy.  The testamentary trusts I use to protect surviving spouses from a nursing home spend down are accumulation trusts. 
An accumulation trust must be carefully designed.  The IRS only allows such a trust to use the beneficiary’s life expectancy to stretch distributions if there is a separate trust for the designated beneficiary.  That is not so difficult, as individuals often draft trusts that create a separate trust share for each child.  However, with an accumulation trust, the designated beneficiary must be guaranteed to be the oldest possible beneficiary of the trust.  The IRS considers all possible beneficiaries when making that determination.  That means that contingent beneficiaries must be limited to persons younger than the designated beneficiary.  No charities may be contingent beneficiaries.  If the designated beneficiary has a power of appointment, the power can only be exercised in favor of individuals younger than the designated beneficiary.  All contingent beneficiary provisions, “wipe-out” clauses and powers of appointment must be carefully examined for compliance with IRS requirements.
A properly designed accumulation trust can provide powerful asset protection benefits for a beneficiary while preserving the tax benefits of stretching an IRA.

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