One of the more difficult questions facing estate and financial planners over the last few decades has been whether or not to name an individual’s trust as the beneficiary of a retirement account. The answer today is a resounding yes!
In a landmark decision (Clark, et ux v. Rameker) in June of 2014, the United States Supreme Court voted unanimously not to consider inherited IRAs – retirement plans that have been left to a beneficiary at the owner’s death - as “retirement funds” within the meaning federal of bankruptcy law. What this means to most of us is that retirement plans transferred outright to our children and grandchildren at our deaths are no longer afforded basic asset protection against the claims of 3rd party creditors.
In making its decision, the Court identified three key differences between an inherited IRA and a traditional IRA. First, the beneficiary of an inherited IRA cannot make additional contributions to the account while the owner of an IRA can. Second, the beneficiary of an inherited IRA must take required minimum distributions in the year after they inherit (regardless of how close they are to actual retirement) while the owner of an IRA can defer doing so until age 70-1/2. Finally, the beneficiary of an inherited IRA may withdraw the entire balance of the plan at any time, for any purpose, and without penalty. The fact that an inherited IRA could be held and used during a beneficiary’s retirement, as the proponents had argued, simply was not persuasive.
Next to one’s home, retirement accounts have become the single largest assets in an individual’s estate. Despite this fact, the conventional wisdom has typically been to keep these types of accounts separate from the trust. Instead, clients were encouraged to bypass the trusts altogether and pass the plan assets by way of beneficiary designation form. This has resulted in significant amounts of family wealth being left outside the governance of a trust and now, according to this new ruling, exposed to our beneficiary’s creditors. Although the Clark decision deals specifically with a bankruptcy matter, clients should expect inherited IRAs to be available to their children’s general creditors, spouses (upon divorce), and even the state for Medicaid spend-down purposes.
The good news is the integration of retirement plans and trust can effectively protect an inherited IRA as long as the trust is properly drafted. In most cases, this means inserting specific language detailing the trustee’s administration and management of these unique assets. In addition, these trusts are often drafted with “see-through” provisions, providing the trustee with the authority to either pay-out the required minimum distributions or accumulate them inside the trust.
The Clark decision serves as a stark reminder that modern estate planning involves more than just estate taxes. If you have not considered a trust as a solution to your wealth preservation needs, now is the time to do so. It is quickly becoming the only viable way of protecting all of your assets, including retirement plans, once they pass to the next generation.
Wakefield Buxton is the Managing Partner at TrustBuilders Law Group a division of Buxton and Buxton, PC. He holds a Master of Laws in Estate Planning and serves clients in the firm’s Yorktown, Williamsburg and Urbanna, VA offices.