What Is an Inherited IRA?
An Inherited IRA, 401K, §357 or §403L Plan and Thrift Savings Plan are retirement accounts that are passed at the death of the owner to someone other than a spouse. Also known as a beneficiary IRA, can include any type of IRA accounts, such as Tradition IRA, Roth IRA, Rollover IRAs, SEP, and Simple IRAs.
Can Creditors Go After IRAs After They're Inherited?
According to the US Supreme Court, an Inherited IRA (or similar plans) are subject to the claims of the beneficiary’s creditors. This means if you leave your IRA or other retirement account to a child or another individual other than your spouse, a creditor (which might include a spouse of a child in a divorce suit) can come after that retirement plan to satisfy their claim.
This would require the beneficiary to cash out the IRA, pay the income taxes due, then pay off the creditor. This is a very expensive result! However, this can be avoided by using an Inherited IRA Trust.
How Does an Inherited IRA Trust Work?
Here is how it works when you put an IRA into a trust:
Creation of Trust: The owner of a retirement plan creates an Inherited IRA Trust then designates the Trust as the beneficiary of the retirement plan.
Stretching Payout Period: Under a properly drafted trust, IRS rules permit the Trustee (which could be the Beneficiary) to treat the IRA as a “Stretch IRA” by looking through the trust to the Beneficiary’s age to determine the IRA payout period.
Distribution over Benefiary's Life Expectancy: Assets in an Inherited IRA need to be distributed over the life expectancy of the Beneficiary as a Required Minimum Distribution (RMD).
RMD’s must begin the year after the IRA owner dies and may continue for the Beneficiary’s IRS determining life expectancy. For example, an 18-year-old according to the IRS, has a 65-year life expectancy. Therefore, the RMD withdrawals from the 18-year-old’s Inherited IRA would have to be distributed out over 65 years beginning the year after the owner’s death.
The first withdrawal amount would be at least 1/65th, the next year 1/64th of the balance and so on each year until the entire life expectancy has consumed the IRA or the Beneficiary dies. Of course, more than the minimum can be paid out anytime during the remainder of the Beneficiary’s life expectancy if needed.
IRS Rules on Retirement Trust Beneficiaries
The IRS, however, has special rules for a trust beneficiary of a retirement account. The regulations indicate that you must meet certain specific requirements in the trust agreement and the RMD payout must be distributed over the age of the oldest beneficiary of the trust.
Therefore, if you left an IRA to a Trust for your sister who is 75, and her child who is 40, both would have to take out their share over the life expectancy of the 75-year old. The payout would be much quicker than over a 40 year old’s life expectancy.
Can I Create a Sub-Trust for Each IRA Beneficiary?
However, the Inherited IRA Trust can be drafted to avoid this dilemma by establishing a separate sub trust for each beneficiary of the IRA, one for the older Beneficiary and one for the younger Beneficiary. Since each sub trust would have only one Beneficiary, the age of each Beneficiary determines the RMD payout period for the Beneficiary.
We call the sub trust a “Legacy Trust” which is established under the Inherited IRA Trust at the death of the IRA owner. At that time, the Trustee will open a Legacy Trust for each beneficiary of the Trust and direct the RMD (or more) be distributed each year in the Beneficiary’s Legacy Trust for his or her benefit. These Trusts are exempt from the claims of the Beneficiary’s creditors, spouses, death taxes, etc, and each can be passed on to their descendants.
If you have accumulated over $100,000 in a retirement account and it could be paid to anyone other than your spouse, you should investigate naming a trust or a sub-trust as a beneficiary for your retirement account.
Questions About Inheritance or Estate Planning Matters?
If you have questions about creating a will, trust, or another estate planning matter, call our team at Trustbuilders Law Group for more information. We can walk you through various ways to efficiently pass down your assets to your loved ones.
Schedule your free consultation today with a member of our team.