Retirement accounts constitute a significant portion of many persons’ estates, representing years of hard work, savings, and savvy investing in a tax-deferred investment portfolio. For many, the balances in their retirement accounts will be among the most valuable assets in the legacy they leave for beneficiaries. In June of this year the U.S. Supreme Court made it clear that for federal bankruptcy purposes, inherited IRAs are not protected from creditors’ claims. More than ever before it is essential to understand the interplay between federal and state bankruptcy laws as they relate to retirement accounts, proactive strategies to safeguard IRAs as they pass into the hands of beneficiaries, and the logistics of transferring and administering IRAs after the account owner dies.
The importance of the new rules on inherited retirement funds may not be apparent. For married couples, when the first spouse dies, the surviving spouse will generally “roll over” the deceased spouse’s retirement plan and make it their own. These retirement funds are indeed protected against creditors, even in bankruptcy, and the rules regarding withdrawals and mandatory distributions are based on the surviving spouse’s age. But what if both spouses are killed in an accident – what do the children get? The answer is simple, an inherited IRA accessible to their creditors and subject to sometimes draconian rules on mandatory disbursements which may be disastrous to the children from an income tax perspective.
A Stand-alone Retirement Trust (SRT) can designate particular beneficiaries which will be used to determine the minimum annual distribution. The younger the designated beneficiary, the better to stretch out the IRA and allow it to accumulate in the trust tax free. A SRT allows you to have a place for your retirement funds even where your children are under 18, disabled or incompetent, or you need to protect the funds against creditors, predators, and future divorce. It also allows a spouse to earmark IRA funds to his or her children regardless of whether the surviving spouse remarries.