By: Heinz Brisske
On June 12, 2014, the United States Supreme Court held that inherited IRAs are not “retirement funds” and therefore not protected from creditors (Clark, et ux v. Rameker, 573 U.S. (204)). Although this development presents a serious risk for clients, it also presents a planning opportunity for their financial advisors.
How Protecting Inherited IRAs in a Trust Benefits Financial Advisors
If a retirement account is seized in a lawsuit, spent down on frivolities, or wrangled from a beneficiary by a predator, those assets leave the advisor’s management. On the other hand, if assets remain protected in trust, they remain under the advisor’s management for a lifetime.
The change in law provides a legitimate reason to contact your clients, review assets, and determine whether there are retirement accounts not yet under your management.
When you spot a vulnerability, you provide more value and increase your clients’ confidence in your relationship.
In the absence of creditor problems now or in the future, a trust can assure the fullest application of the power of stretch distributions.
The financial advisor is in a position to continue providing management and advice to the beneficiaries.
What Kind of Trust is Appropriate to Protect Inherited IRAs?
By far the best option for protecting retirement accounts is to create a Standalone Retirement Trust (SRT) for the benefit of all of the intended beneficiaries. If properly drafted, this type of trust offers the following advantages:
Protects the inherited retirement account from beneficiaries’ creditors as well as predators and lawsuits;
Ensures that the inherited retirement account remains in the family bloodline and out of the hands of a beneficiary’s spouse, or soon-to-be ex-spouse;
Allows for experienced investment management and oversight of the retirement account assets by a professional trustee;
Prevents the beneficiary from gambling away the inherited retirement account or blowing it all on exotic vacations, expensive jewelry, designer shoes, and fast cars;
Enables proper planning for a special needs beneficiary;
Permits minor beneficiaries such as grandchildren to be immediate beneficiaries of the inherited IRA without the need for a court-supervised guardianship; and
Facilitates generation-skipping transfer tax planning to ensure that estate taxes are minimized or even eliminated at each generation.
Planning Tip: Additional value is created when provisions are made for the benefit of a spouse. This may be important for many reasons aside from creditor protection, including a second marriage with a blended family or, when coupled with disclaimer planning for a spouse who eventually needs nursing home care and seeks to qualify for Medicaid. A layered retirement account beneficiary designation which includes a Standalone Retirement Trust and disclaimer planning can offer a great deal of flexibility for clients who want to ensure that their hard-saved retirement funds stay in their family’s hands and out of the hands of creditors and predators.
What about the “Stretch”?
Stretch distributions is a term that applies to the beneficiary’s ability to “stretch” distributions over his or her life expectancy. Generally, the IRS provides that a named individual beneficiary can, in effect, annuitize distributions for an extended period, determined by IRS tables available for that purpose. Naming an individual beneficiary, however, often provides too great a temptation “never to touch” the inherited retirement account, and the “best-laid plans” can go astray. The required minimum distribution of an inherited IRA or retirement plan actually begins as a very small percentage, but just a little bit extra taken from time to time will destroy the accumulation and tax deferral power.
If the retirement account or IRA is in a trust, an independent Trustee is in charge of the distributions, rather than the individual beneficiary. If properly drafted, an SRT qualifies as an individual for distribution purposes, so that the trust qualifies to “stretch” the distributions over the trust beneficiary’s lifetime, while still being protected within the trust. Because distributions are determined by a Trustee, it is far more likely the the inherited IRA will actually fulfill its purpose of providing for a lifetime of distributions to the beneficiary.
The Bottom Line: Protecting Inherited Retirement Assets
Given the amount of wealth held inside retirement accounts, planners must become adept at helping their clients figure out who or what to name as the beneficiary of these assets. The change in law has amplified the need to become knowledgeable about the pros and cons of all of beneficiary choices for retirement assets. An SRT should definitely be one of the choices under consideration as beneficiary of an IRA or other retirement asset.
SRTs are certainly not one-size-fits-all planning and can only be done on an individual, case-by-case basis. We are here to answer your questions about protecting beneficiaries of retirement accounts through Standalone Retirement Trusts, disclaimer planning, and layered beneficiary designations. Feel free to call with questions; we’re always happy to help.