By Allyn Hughes, CFP®, ChFC®, CLU®, CAP®
A Supreme Court decision on June 12th has changed the way that the government treats inherited IRAs.
This change could have some important ramifications for individuals.
Some background. Each IRA owner can name one or more beneficiaries. When the IRA owner dies, ownership of the account transfers to the stated beneficiary. Usually, this account is retitled in the name of the new owner and labeled an “inherited IRA.”
In the past, the government treated an inherited IRA much like a Rollover IRA or government approved retirement plan (i.e. 401k, 403b or 457 plan etc.) when it came to protecting these assets if the owner declared bankruptcy. In these cases, the creditors of the bankrupt retirement plan owner could not go after these “retirement” assets.
In this new decision, the Supreme Court ruled that money in a retirement fund ceases to be a retirement fund after the owner dies. They ruled this way because the new inherited IRA owner:
1) “Can never invest any additional money in the account,”
2) “Must take annual distributions from this account,” and
3) “May withdraw the entire balance of the account at any time—without a penalty.”
Assets in inherited IRAs are therefore excluded from being labeled as “retirement funds.” That means that any assets held in an inherited IRA lose this asset protection and could be garnished by a creditor.
Some lawyers are concerned that this ruling could also apply to IRAs inherited by surviving spouses. Spousal beneficiaries have the option to roll over inherited IRA assets into their own IRA continuing the “retirement” nature of the account. If they do not roll over assets into their own IRA account or if they make withdrawals from the original IRA and place that money outside of a retirement account, those funds could be eligible to creditors. The Bankruptcy code will have to be updated to make more specific declarations about the protection of spousal IRAs.
Lawyers are looking into ways to try to overcome this issue. One way is to consider making an outright bequest of an IRA to a spouse before you die. Another suggestion is to put the IRA into a separate fully discretionary trust that could provide alternate protection for the owners.
This change may create a tidal wave of work for estate planning, retirement and ERISA lawyers and bankruptcy lawyers for many years.
~ Brooks, Hughes & Jones Wealth Advisors – Tacoma, WA