Everyone knows that IRAs are a great way to save for retirement, but the potential to protect against creditors is another valuable aspect of these accounts. Is the same protection extended to beneficiaries? This article from Forbes, “Estate Planning Tip: Creditor Protection for IRAs & Beneficiaries,” explains in detail how these rules apply to various bankruptcy situations and the issues to consider when naming your IRA beneficiaries.
Bankruptcy. Similar to the protection offered to pensions, 401(k)s and Social Security benefits, IRAs can be protected from creditors in bankruptcy. If you declare bankruptcy, your IRA assets will typically be safeguarded and can’t be taken. However, this doesn’t extend to other types of judgments, civil lawsuits, or IRS levies. State laws will vary, but your IRA assets may be protected from other creditors. There is a $1 million inflation-adjusted limit that applies to federal bankruptcy protection rules for the aggregate value of Contributory and Roth IRAs. Assets rolled over to an IRA from a qualified plan, like a 401(k), aren’t subject to the same dollar limits and can be fully protected.
Protection for Beneficiaries. A big benefit of IRAs is the simplicity in selecting a beneficiary to receive the money when you die. This can be a great estate planning tool because these assets are not subject to probate and pass directly to the beneficiary. Make sure that your beneficiary designations line up with your estate plan, however. Because it’s a contract, the financial institution will be required by law to give those assets to whomever is listed on the beneficiary designation form. If you haven’t checked to ensure everything is aligned with your plan, it could pass to a beneficiary you didn’t intend.
Beneficiaries of IRAs are not always given the same creditor protection as the original account owner, so you need to consider this when selecting your IRA beneficiary. An inherited IRA for a non-spouse beneficiary is no longer automatically protected from creditor’s claims when the beneficiary files for bankruptcy. When the owner dies, and the non-spouse beneficiary takes ownership of the account, the assets are no longer deemed retirement funds, and can be seized in bankruptcy.
This only applies to non-spouse beneficiaries because a spouse can roll over inherited IRA assets into his or her own account. When this transfer occurs to a surviving spouse, the assets are once again protected. However, a non-spouse beneficiary can’t commingle inherited IRA assets with their own retirement assets. Check your state laws on the degree of protection over non-spousal inherited retirement funds.
So how can we protect IRA assets for beneficiaries, especially if we want to pass those assets on to kids or grandkids? Let’s take a look at some planning opportunities for children when passing on an IRA.
Children as beneficiaries. Many parents opt for their children to be beneficiaries of their IRA accounts. This can be an issue if the children have financial issues or face debt collectors. You can get around this be creating an inherited IRA trust for the benefit of your child, and by listing the trust as beneficiary of the IRA, not the child. As a result, an inherited IRA payable to a trust can be protected from the child’s creditors and even divorce decrees, while still allowing the child to benefit from the inheritance. The IRA’s required minimum distributions are calculated on the trust beneficiary’s life expectancy, and income is taxed at the beneficiary’s tax rate. Since the assets aren’t legally owned by the beneficiary, they’re protected from creditors in most instances. However, keep in mind that once the income is paid out to the beneficiary, that income isn’t protected.
Like so many other parts of your estate plan, IRA beneficiary designations should be reviewed regularly. Your own goals may change, and your beneficiaries will also experience changes in their lives. If a child is going through a divorce, for instance, you may want to work with a qualified estate planning attorney to find a way to protect your legacy and your child. Your state’s laws on creditor protection may change, as may tax laws.
Since change is life’s only constant, we at Family Estate Planning Law Group work with all our clients on an ongoing basis. Because your goals, family situation, assets and the law will all change over time, your estate plan will need to change, too, to ensure it addresses your circumstances accurately when it actually needs to be used.
For more information about the importance of working with an estate planning attorney on an ongoing basis, explore our website and contact us to schedule your consultation today!
Reference: Forbes (December 9, 2016) “Estate Planning Tip: Creditor Protection for IRAs & Beneficiaries”