Inherited IRAs Not Protected in Bankruptcy; Trusts Become More Desirable As IRA Death Beneficiaries
The Supreme Court of the United States has held that inherited IRA assets are not exempt from bankruptcy claims by an inheriting individual beneficiary’s creditors.
In estate planning, the Supreme Court opinion may make it more desirable to name a trust as IRA death beneficiary, rather than naming an individual as outright, direct beneficiary. While nothing is “bulletproof,” a trust can usually provide some protection against an inheriting beneficiary’s creditors, if drafted with that in mind.
The trust alternative is not perfect. An IRA trust is more expensive and cumbersome to create and administer than an IRA directly inherited by an individual. Trusts must contain specialized terms to extend taxable IRA distributions over the beneficiary’s lifetime, and those terms may reduce the asset protection the trust provides. If the trust is drafted to maximize its asset protection potential, anticipate accelerated IRA distributions reducing income tax deferral opportunities and higher effective tax rates on IRA distribution income.
The Supreme Court opinion does not affect the status of an IRA during the original contributor’s lifetime vis-à-vis that individual’s creditors. It only affects an IRA after the original contributor dies.
Here is a link to the Supreme Court’s short, unanimous opinion:
http://www.supremecourt.gov/opinions/13pdf/13-299_mjn0.pdf