For many people, their Individual Retirement Account (IRA) is one of their largest financial assets. However, if you’re planning to leave your account to your heirs, special planning strategies are needed to ensure that they are guarded against creditor claims and not subject to unnecessary taxes.
Proper Planning Provides Maximum Protection
Since IRAs receive special tax treatment, their ownership can’t be changed without the transfer being treated as an income taxable event. This is why people rarely choose to change the ownership of an IRA and why it is advisable to carefully consider your options when the account is set up.
When IRA planning, you have three general options:
Name an individual as the beneficiary
Naming a beneficiary is the simplest choice, but the most problematic because it creates tax concerns as well as opening up the account to creditor claims.
Name a testamentary trust created in a will or living trust as the beneficiary
With the living trust option, the trust must be a “see-through trust” and will still require the IRA account to be withdrawn (and taxes paid) within the 10 year time frame. This can be a problem if the beneficiary has a substance abuse disorder, is prone to wasteful spending, or has outstanding judgments.
Name a standalone retirement trust as the beneficiary
This is often the best solution, as it can protect the inherited IRA from each beneficiary’s creditors, ensure the funds remain in the family bloodline, prevent wasteful spending, and provide for continued growth via management by a professional trustee. The standalone retirement trust will have provisions for retirement accounts that are separate from your revocable living trust and designed to take advantage of specific IRS requirements allowing for the continued accumulation of assets placed within the trust.
Inherited IRAs and Creditor Concerns
Retirement funds are generally protected against creditor claims, but this protection doesn’t extend to inherited accounts. In June 2014, the U.S. Supreme Court discussed this issue in Clark, et ux v. Rameker, 573 U.S. The Court found that an inherited IRA does not receive the personal protection associated with an individually created account and can be considered an asset in a bankruptcy.
Some states, such as Alaska, Arizona, Florida, Idaho, Missouri, North Carolina, Ohio, and Texas, have since passed their own laws to provide protection under state bankruptcy exemptions that can be used for federal purposes. However, Arkansas has taken no such action and is unable to do so due to the specific terms of its 1874 constitution.
In addition to the risk of losing funds in an inherited IRA to bankruptcy, your heirs could be vulnerable if they were ever sued as the result of a personal injury claim or premises liability case. The IRA funds could also be lost when assets are divided in a divorce proceeding.
Inherited IRAs and Tax Liability
Typically, the owner of an IRA who wants to begin making withdrawals can do so when they are age 59 ½, and Required Minimum Distributions (RMD's) must begin by age 72. This allows individuals to delay paying taxes until they’ve retired and ideally moved into a lower tax bracket.
Inherited IRAs are treated differently. If you are not an eligible designated beneficiary, or trust or other entity, you must withdraw all assets from the inherited IRA within 10 years (for those whom the original account owner died January 1, 2020 or after). These withdrawals are taxed at the person’s current rate.
If a person inherits an IRA during their peak earning years, they’ll be in a higher tax bracket. They could easily owe thousands of dollars in extra taxes due to the lack of proper planning. Additionally, they are missing out on a valuable opportunity to continue to grow the asset.
IRA Protection Planning Is Just One of the Many Services We Offer
At Quraishi Law Firm & Wealth Management, we know that every client has unique financial goals and concerns. We’ll take the time to learn more about you, your family, and your needs before recommending specific IRA protection strategies that can be incorporated as part of a comprehensive estate plan.
Our estate planning attorneys are available at our Jonesboro and Little Rock office locations to serve clients throughout Northeast and Central Arkansas. We are also available to meet with clients in our Memphis, Tennessee office, so don’t hesitate to contact us to set an appointment to discuss how we can best be of service.
1. Eligible designated beneficiaries include a surviving spouse, a minor child of the deceased owner, disabled or chronically ill individual or any other person who is not more than 10 years younger than the deceased account holder. Eligible designated beneficiaries have the option to take Required Minimum Distributions based on their life expectancy.