Most of us have qualified retirement accounts. Whether they’re an IRA, 401(k) or other qualified retirement account, we’re all generally familiar with their existence. However, did you know that you need to be careful when planning to give an IRA to an heir? An article from NerdWallet highlights some of the important planning aspects of these retirement assets.
A few years ago, the Supreme Court ruled in the Clark v. Rameker case that inherited IRA assets don’t retain their special protections once passed from the original owner to an heir. That opened up inherited IRAs to seizure by creditors in bankruptcy proceedings, divorce actions, etc.
If you’re looking to bequeath an IRA account—or know you’ll be receiving IRA assets at the death of a family member or loved one—you’ll want to learn more about the special rules around IRAs. A spouse can roll over your IRA into their own, if they choose. Rolling over the IRA into a spouse’s existing IRA account means keeping the IRA’s creditor protections.
If you’re passing a large IRA account on to any beneficiary, however, it may get tricky. In this situation, trust planning may be best. There are several types of trusts you and your estate planning attorney could choose, but the two most common are conduit trusts and accumulation trusts.
A conduit trust must be named as the beneficiary on your IRA’s beneficiary designation form for this plan to work. When the IRA owner passes away, the beneficiary designation directs the account into the trust and the trustee must make any required minimum distributions (RMDs) out to the trust beneficiary. RMDs are calculated based on the trust beneficiary’s life expectancy and taxed at their tax rate.
If you’re passing the account to multiple beneficiaries, most estate planning attorneys create a conduit trust for each beneficiary. Conduit trusts can also be a safeguard against irresponsible spending by heirs, as well, since the trustee has some control over the distributions of the assets, including the option to distribute an amount over the RMD. However, there is a downside to a conduit trust. The RMDs, once distributed to the beneficiary, are exposed to any creditors, divorce action, etc.
The other option is an accumulation trust. This type of trust also has a separate trustee who is not the beneficiary, but unlike the conduit trust, the trustee has the option to keep RMD amounts in the trust instead of distributing them. That could allow the assets in the trust to grow over time and the trustee may distribute at his or her discretion.
The caveat here is that if the RMDs plus other trust income exceed $12,500 in 2017, the income is taxed at the top rate of 39.6%. Additionally, an accumulation trust must contain carefully drafted language in order to use an underlying beneficiary’s life expectancy to calculate the RMD amount. Especially if a beneficiary is in a more litigious profession, such as a physician, an accumulation trust can be the better option. Since the trustee can decide not to distribute trust assets to the beneficiary, the trust assets are generally protected from creditors. Even if a judgment is entered against the beneficiary, trust assets cannot be taken to satisfy the judgment.
These types of trusts are complicated and there are many rules around them. For example, beneficiaries cannot contribute to an inherited IRA. Because of these and other complexities, it’s best to work with an experienced estate planning attorney to create the trusts and to work with you to ensure all beneficiary designations are appropriate, correct and verified with the financial institutions.
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Reference: NerdWallet (January 26, 2016) “Protect Inherited IRA Assets from Creditors with a Trust”