Thought Leadership on Corporate Financial Wellness presented by Raskin Gobal.
A 2014 Supreme Court ruling has left individuals who want to leave their retirement accounts directly to their heirs scrambling to make important changes that will protect those accounts from heirs’ creditors.
Or, at least it should have you scrambling.
Here’s what happened, why retirement accounts are only the tip of the iceberg, and why you need to be among those who see the big picture:
Ruth Heffron established a traditional IRA in 2000 and then died in 2001, leaving $450,000 in the IRA.
Ruth’s daughter, Heidi Heffron-Clark was the sole beneficiary-on-death of Ruth’s IRA and, upon Ruth’s death, Heidi began to take monthly distributions from the IRA.
Heidi did this until 2010, when she and her husband filed for bankruptcy under Chapter 7.
The inherited IRA, however, was listed as an exempt asset.
This is where things got sticky because Heidi’s creditors and Bankruptcy Trustee completely disagreed.
The Bankruptcy Trustee and creditors stated that based on the federal bankruptcy law, the money from the inherited IRA was simply that, inherited money, and nowhere near met the criteria of being exempt retirement funds.
The Bankruptcy Trustee and the creditors won the case, but then the situation got even more interesting.
The District Court responsible for reviewing Bankruptcy Court decisions in the Seventh Circuit disagreed with the ruling, finding in favor of Heidi and her husband.
The Seventh Circuit, however, agreed with the Bankruptcy Trustee and creditors and reversed the District Court’s decision.
This created a conflict and the U.S. Supreme Court stepped in.
So, what happened?
The Supreme Court agreed with the Appeals court, declaring that inherited IRAs will not be exempt and cannot be protected from creditors.
Justice Sotomayor (writing for the court) outlined three reasons for not allowing inherited IRAs protection from creditors and bankruptcy – delineating for the record why inherited IRAs are not actually retirement accounts under law:1
- Inherited IRA owners cannot contribute to the account as a retirement account.
- Inherited IRA owners must take annual withdrawals (required minimum distributions) from the account, which applies regardless of whether they are retired or of retirement age.
- There are no age-related penalties for withdrawals from inherited IRAs.
Clearly, inherited IRAs are not bound by the same rules and restrictions as retirement accounts and are, therefore, not retirement accounts.
This brings us to the scrambling happening right now. Specifically, to help retirement account owners protect future inherited IRAs from their heirs’ creditors.
It’s important to note that although some states’ laws do protect inherited IRAs, it’s the state of residence of the debtor at the time of a claim that matters, not the residence of the original account owner.
Given that there’s no way to truly know which state your beneficiaries will be living in at the time of your death – not to mention, to know for certain that they won’t move sometime after your death – it just doesn’t make sense to take the risk of relying on state laws when a better solution exists.
Protecting inherited IRAs from heirs’ creditors can still be accomplished. Special IRA trusts can be used to maintain the assets’ protection.
In other words, if you have accumulated significant amounts in your retirement accounts – whatever significant means to you and your heirs – you may want to make some changes – and fast.
Of course, when it comes to taxes, inheritances, trusts and the law, it is never cut and dry.
There are instances where it may be better to designate your spouse as the direct beneficiary upon death, and not a trust. There is also the reality that creditor and bankruptcy issues will only impact a small portion of future heirs.
But the new ruling does make one thing perfectly clear:
Unless you are up to date on every nuance of estate planning, it pays (for both you and on behalf of your heirs) to work with a competent advisor who’s willing to dig deep into your unique situation and refuses to apply a one-size-fits-all approach to your financial future.
1 573 U. S. ____ (2014); find the full ruling at: http://www.supremecourt.gov/opinions/13pdf/13-299_6k4c.pdf
Leonard Raskin is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. Raskin Global is not an affiliate or subsidiary of PAS or Guardian. Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. 2016-29413 Exp 10/18