7th Dec 2018
IRAs (Individual Retirement Accounts), along 401(k)s are becoming increasingly popular with working Americans as means to save for retirement. Roth and traditional IRAs are able to be invested on a tax-deferred basis, which makes them the greatest source of financial assets among the majority of American households. However, there has been much debate as to whether IRAs as part of estate plans are safe from creditors.
While they are safe from bankruptcy, they may not be safe from creditors in the event of the holder’s death. The following article will discuss how to protect your IRAs from creditors and bankruptcy.
Retirement Accounts and Bankruptcy
IRAs as well as pensions and 401(k)s and Social Security benefits, are protected from bankruptcy. Should you choose to declare bankruptcy at any time, the assets in your IRA are protected. However, they are not protected from civil lawsuits, levies by the Internal Revenue Service (IRS) or other such judgements. IRA assets are protected in some states from specific creditors, but the rules per each state are different.
Those assets which have rolled over from a qualified retirement plan to an IRA are not subject to the same dollar amount as for the aggregate value of Contributory and Roth IRAS, which is one million inflation adjustment that is held by rules of the federal bankruptcy rules. Thus, they are fully protected.
What about Protection for Beneficiaries?
One of the primary advantages of an IRA is that you are able to designate a beneficiary to receive your assets and financial wealth upon your death. This is an ideal tool for estate planning as it ensures that your assets will pass directly to your designated beneficiary and will not be subject to the probate process. This is a great way to ensure that the terms of your estate plan are properly executed.
This requires a great deal of careful planning on your part. An estate plan, as well as an IRA, gives you control over the dispersion of your retirement plan even if you have not prepared a last will and testament.
However, IRA beneficiaries are not subject to the same protection from creditors as the original IRA owner. Keep this in mind when it comes time to choose your beneficiary for your IRA. In a ruling by the United States Supreme Court, a non-spouse inherited IRA is not under protection from creditors if they file for bankruptcy. This is under the assumption that since the original account holder has passed away and the assets are now the property of the beneficiary, these asses are longer to be considered retirements funds. Thus, they are subject to bankruptcy proceedings and are in danger of being seized by the court and creditors.
This applies to
non-spousal beneficiaries only due the fact that a spouse will be able roll
over the assets of the IRA which was inherited from their deceased spouse into
their own retirement account. In this event, the assets are in fact protected.
However, if the beneficiary is not a spouse, they are not able to commingle the
assets of the deceased with their own IRA or other retirement funds.
Does This Mean That Beneficiaries Are Out of Luck?
As many parents designate their children as their beneficiary for their IRA accounts, this will indeed be an issue if the kids have debt or financial issues. However, there are ways to resolve this.
The best way to prevent any issues for your beneficiaries is to create a conduit trust in which you designate the trust as the IRA beneficiary as opposed to the offspring. In this instance the trustee will be protected from creditors and bankruptcy hearings while still allowing the child to receive the inheritance as opposed to if they were named as the sole beneficiary.
As such, the IRAs minimum distributions will then be formulated based per the life expectancy of the designated trustee, thus the income tax is now based on their tax rate.
The assets are
protected from creditors in most cases as they are held by the trust rather
than the beneficiary. Keep in mind that once the beneficiary has been paid
income it will no longer be protected.
You should review your IRAs and beneficiary designations at least annually to ensure that everything is current. Also, if one of your beneficiaries are experiencing difficulties with their finances, you might want to consider changing your beneficiary on your IRA to protect your assets. Also, remember that the laws differ from state to state. Consult your tax attorney or estate planning attorney to be informed of the current laws in your state.