Consider Naming a Trust as the Beneficiary to your IRA or Your Heirs Could Lose it to Their Own Creditors! 2014 Supreme Court Case Allows for Creditors in Bankruptcy to attack an IRA.

In 2014 the United States Supreme Court held that an inherited IRA  was not protected from the claims of creditors. In that case the beneficiary of an inherited IRA filed for bankruptcy and the Court held that her bankruptcy estate could not exclude the IRA she inherited from her Mother. This subjected it to the beneficiary’s creditors. As a result of this decision, if you are concerned about creditors of a beneficiary reaching the inherited IRA, you may want to consider creating a trust for the individual you want to benefit and naming the trust as the beneficiary of the IRA.

 Your Spouse or Other Individuals

• Prior to this case, many advocated the simplest approach – to just name an individual as your beneficiary for your IRA.
• Typically married individuals name their spouse allowing the spouse to roll over the IRA into the spouse’s own.
• As a result, the surviving spouse can delay taking required minimum distributions (“RMDs”) until age 70½, thus deferring income taxes. If your spouse chooses the rollover, the surviving spouse can name a new beneficiary to receive the IRA at the surviving spouse’s death.
• If an individual other than your spouse is named, the individual beneficiary can also elect“stretch treatment” and receive distributions over the beneficiary’s life expectancy. This stretch approach permits the value of the inherited IRA to continue to grow tax deferred.

With the Supreme Court’s ruling in 2014 this may not be the wisest idea, so here is an alternative to consider: Trust Beneficiaries for your IRA.

Trusts as Beneficiaries

• Many considered this prior to 2014 for a variety of reasons one of the most common being second marriages with children from other marriages means a spouse may wish to protect their own children as well.
• If you have a vast IRA that may pass to minor beneficiaries, you should consider naming a trust or custodian under the Uniform Transfers to Minors Act (“UTMA”). Otherwise, a court proceeding may be required to appoint a guardian to manage your IRA for your minor child.
• Remember though, naming a custodian under the UTMA may not be the best option for larger IRAs since the UTMA provides for management of assets in an UTMA account only until the beneficiary reaches 21.
• If the assets in your IRA are big enough, you may want to consider naming a trust as the beneficiary as an alternative; by naming a trust as the beneficiary, you can choose the age which the trust’s beneficiary must attain before the trust terminates and ensure that your IRA can continue to be managed for the benefit of that beneficiary after the age of 21.
• Similarly, if you have a concern that a shortsighted beneficiary might immediately cash out your IRA, a trust may be a better alternative than naming the individual outright.

Remember that naming a trust as your beneficiary has some book keeping that must be done as well:

1. The trust must be drafted correctly.
2. In order to qualify for things like stretch treatment there must be specific provisions.
3. For Large IRA’s compression of distributions may result in a beneficiary being bumped into another tax bracket.