It’s Time To Reconsider IRA Beneficiaries

By: Elizabeth A. Hartnett

Have you named your children as beneficiaries of your IRA? Perhaps it is time to re-think that decision.

A recent United States Supreme Court ruling raises concerns about asset protection and the designation of IRA beneficiaries. In June the high court unanimously ruled that, under federal law, an IRA that is owned by a beneficiary is not protected in bankruptcy. The ruling does not affect the bankruptcy protection from creditor claims of an individual’s IRA. Rather, it exempts from bankruptcy protection any IRA that has been inherited. This means that IRAs that are transferred by an IRA beneficiary after the IRA owner’s death to an IRA in the beneficiary’s name could be lost to creditors’ claims if the beneficiary files for bankruptcy.

Some inherited IRAs may be protected under state law. Seven states- Alaska, Arizona, Florida, Missouri, North Carolina, Ohio and Texas- have laws expressly exempting inherited IRAs under their bankruptcy statutes. New York State does not have such protection.

An IRA owner who wishes to name a child as beneficiary may want to reconsider if bankruptcy or creditor protection for such a child-beneficiary is important. It may be best to name a trust for the benefit of such child as the IRA beneficiary. A trust can shield assets from the creditors of the beneficiary but still allow for the favorable tax implications of an inherited IRA, including the ability to stretch distributions over the life expectancy of the trust beneficiary.

The need for creditor protection should be weighed against the drawbacks of a trust. Trusts are complex and incur accounting and trustee fees. Additionally, trusts pay taxes at a higher tax rate than individuals.

Since the Supreme Court decision did not address spousal beneficiaries and bankruptcy, it is not clear whether the decision affects a spouse who inherits an IRA. Generally, a spouse would do a spousal rollover into an IRA in their own name rather than utilize an inherited IRA and that may mean that a rollover IRA continues to enjoy bankruptcy protection. Nevertheless, the implications of creditor protection should also be considered when a spouse is named as a beneficiary.


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