Early last year the U.S. Supreme Court mandated that inherited IRAs are not entitled to the same creditor protection as other retirement accounts. Does that mean you should change your IRA beneficiaries? Maybe. We’ll take a look of course but let’s get some perspective first.
What is an Inherited IRA?
If anyone other than your spouse inherits your IRA, the account is classified as an Inherited IRA. So if you name your nephew Jason the beneficiary of your IRA and you pass away, Jason becomes the proud new owner of an Inherited IRA. That’s the good news. The bad news is the money isn’t as safe in Jason’s hands as it used to be when it was in yours.
What does the new law mean?
The Supreme Court decided (Clark v. Rameker, 6/12/14) that Inherited IRA accounts aren’t protected against creditors like normal retirement accounts often are. So if your inherited IRA beneficiary files bankruptcy that inherited IRA is fair game for creditors.
Should You Change Your IRA Beneficiaries Now?
Maybe…but if you picked the right beneficiaries from the get go, you probably don’t need to do anything now. If your beneficiary has a high risk of being sued, you might want to re-think putting all that dough in their hands. On the other hand, it’s usually pretty difficult to predict if someone is going to get sued or not.
Another option is to create an irrevocable trust and name it as the beneficiary of your IRA. Then, name the individuals the beneficiaries of the trust (not the IRA). If the trust is set up carefully the beneficiaries will have a great deal of protection against creditors and still enjoy the benefits of an Inherited IRA.
But if you go this route tread carefully. Make sure the lawyer who drafts the document is an expert with irrevocable trusts. If not your beneficiaries might lose both the creditor protection and the tax benefits of the Inherited IRA.
It’s only natural to want to protect your beneficiaries. They are going to inherit the assets you’ve worked so hard to build up during your lifetime. But at some point we lose control. We can carefully select beneficiaries and create trusts but that’s about it.
What measures are you prepared to take in order to protect your beneficiaries? Is it worthwhile to set up a special trust? Why or why not?