A. Perhaps. In certain circumstances, naming a trust as the beneficiary of an IRA is an appropriate technique. Alternatively, for many typical family situations, making your spouse the primary beneficiary and your children as contingent beneficiaries has been the recommended structure. Recently, the US Supreme Court held that inherited IRAs are not “retirement funds” that would otherwise be exempt from creditors’ claims in bankruptcy. This ruling means that while your IRA is protected under federal bankruptcy law, if you inherit an IRA, it lacks similar protection.
There are some exceptions. If you name your spouse as the beneficiary of your IRA, he or she can convert it from an inherited IRA by “rolling it over” into her own IRA. The “roll-over” IRA should offer the same bankruptcy protection as your spouse’s own IRA. This, however, does not apply to the children.
The lack of creditor protection for inherited IRAs can be addressed by naming a trust as the beneficiary of the IRA. The trust can be used to benefit your spouse or one or more children. Even if you do not expect one of your children to file for bankruptcy, a trust can protect the IRA assets from other creditors, namely a divorcing spouse of a beneficiary.
Other potential advantages of naming a trust arise in the event of minor or spendthrift beneficiaries, or second marriages. Absent a trust, a minor beneficiary would have unfettered access to the entire IRA at age 21. Although a person inheriting an IRA can generally “stretch out” distributions and enjoy built in tax advantages, that same person can withdraw all of the funds immediately. The use of a trust can limit or control their access to the funds and still provide the tax- advantaged “stretch”. Also, the person cannot designate a new beneficiary if the IRA is paid into a trust.
While creating a trust or amending an existing trust to accept your IRA when you pass away is a well-established technique, it is a technical exercise and can be complex. Certain federal rules must be followed. This is an area that requires specialized expertise and you want to be sure you consult with an experienced estate planning practitioner. Done incorrectly, things can go very wrong.
Whether you ultimately decide a trust is appropriate for you, be sure to review, and if necessary, update your beneficiary designations with your IRA custodian. Out-of-date designations often result in harsh and unintended consequences.
Christopher Paul can be reached at [email protected]
Know the Law is a bi-weekly column sponsored by The McLane Law Firm.