Thursday, May 6, 2010

Protecting Your IRA


With the downturn in the economy, it is hardly surprising that creditors are getting more aggressive and creative in their efforts to reach the assets of debtors. There have been several cases recently which resulted in creditors successfully seizing a beneficiary’s interest in an inherited IRA.


To give the reader some perspective, assets held in an IRA which originated with the owner (i.e. the owner of the IRA who actually made the initial contributions) are universally protected under the laws of the 50 states. The amount which is protected varies from state to state, but protection exists, nevertheless. Nevada makes $500,000 of an IRA owner’s accounts exempt from attachment by creditors. It may be helpful to note that ERISA retirement plans, such as 401(k)’s, 403(b)’s, qualified plans, etc. should have unlimited protection. Therefore, anyone considering rolling such a qualified plan into an IRA should think about the possible exposure which could occur when rolling a fully‐protected plan into an IRA with limited rotection.

As long as the IRA is $500,000 or less, the IRA owner’s creditors will not have a claim against the IRA and there is no requirement that the required minimum distribution be paid to the creditor. Therefore, if the IRA owner is careful, even after reaching age 70 ½, the distributions can be received and creditors will not be able to reach the distributions.

When an IRA owner dies, and the remaining IRA passes to a beneficiary, the beneficiary can usually opt to take the IRA as an “inherited IRA”, which allows the new beneficiary to obtain continuing tax deferral on the IRA, with minimum distributions not required until the end of the first year following the death of the IRA owner (and the first year minimum distribution may actually be deferred until April 15th of the following year). In two recent cases it was held that an inherited IRA does not receive protection from the creditors of the beneficiary of the inherited IRA. These cases were a surprise to many attorneys who practice in the asset protection area of the law; nevertheless, they must be recognized and dealt with. (On a positive note, one recent case did hold that an inherited IRA is protected.) The point is, that in the current environment, one cannot be certain of the protection which a court may grant to an inherited IRA.

There is a fairly simple method to avoid a bad result and that is to make your trust the eneficiary of your IRA and then allow the trustee to accumulate required annual distributions and make distributions in the trustee’s discretion. With this approach, a creditor would be blocked from getting at the IRA because of the trust holding the IRA, as well as the accumulated distributions. The trustee can still make distributions, and because there is no duty on the part of the trustee to inform the creditor that a trust distribution will be made, the funds can be distributed out to the beneficiary with minimal risk of the creditor seizing them. Care must be taken in drafting the trust which will be the IRA beneficiary to ensure that maximum tax deferral of distributions will be achievable. If you are concerned about your beneficiaries losing the IRA they will inherit from you, it may be wise to give us a call to explore some solutions to these potential pitfalls.


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