The U.S. Supreme Court this summer unanimously ruled that inherited IRAs are not retirement accounts. Patrick Simasko, founder of Simasko Law in Mount Clemens, spoke with DBusiness Daily News about what this means and how a few changes to an estate plan can protect an account from creditors after it has passed on to its beneficiaries.
1. DDN: What does this ruling mean, and how does it change things?
PS: Let’s say your dad has an IRA. If he ever got sued, that money would be protected from the lawsuit and bankruptcy court because it’s a retirement account. If he passed away, it would roll into your mom's name, and would also be protected from creditors since it’s her IRA. Now let’s say they both pass away and you inherit the IRA. Historically, it would also be protected from creditors and bankruptcies, but every state handled it a little bit differently. And when it went up to the Supreme Court, the (court) came down and said they weren’t protected for the beneficiaries if they got sued or have to file for bankruptcy. It's really quite a major law change.
2. DDN: What was the rationale behind the ruling?
PS: Because they’re no longer IRAs. They’re inherited IRAs, and they’re not really a retirement account at the point. And there’s a few reason for that. One is that you can’t contribute to the account anymore. Another is that you can’t take money out of a retirement account until you’re 59 and a half, but if it’s a beneficiary IRA, you have to start taking out the minimum required distribution based on your age, and most people don't understand that. The good thing about IRAs or inherited IRAs is you can stretch out the payment of the taxes over your whole lifetime. You don't have to cash them in all at one time.
3. DDN: What might stop someone from just taking out all of the money at once and put it into another IRA?
PS: It's taxed as it comes out. So if you pull out all $300,000 at one time, you're going to be (paying) at the highest tax bracket. If you’re only pulling out $2,000 or so at a time, you’ll be paying at a lower tax bracket. And if you pull the money out of an inherited IRA, you're not allowed to put it into another IRA, because there are limitations as to how much you can put into a retirement account each year. You'd have to treat it as a non-IRA account.
4. DDN: What can people do to protect inherited IRAs from creditors?
PS: That's where the legal planning comes into play. It’s called a standalone inheritance trust, or an IRA trust. So when someone dies, and it goes to their three kids, (beforehand, the giver would) pick the “good kid” to watch over the distribution. It’s called a conduit trust, which is designed so IRA distributions flow through the trust. You still have to take out your required minimum distributions, but the principal would be protected if you have the creditor protection language in the trust document. It also means (one beneficiary) just can't cash it in immediately. And if another (beneficiary) happens to be going through a divorce, it's a separate asset, and would be protected since it won’t be treated as part of the marital estate.
5. DDN: Do your clients often include IRAs in their estate planning?
PS: Not in a trust, because normally IRAs stay outside of the trust. With 99 percent of the people we see, their IRAs are the last things that they have left over that goes down to their kids or grandkids, no strings attached. By putting these funds in trust documents, mom and dad are allowed to put all of the strings they want on their accounts when they pass away.