Act now! Avoid new Supreme Court decision on inherited IRAs
By Debbie J. Papay, Attorney FLT News Columnist – Have you ever looked at one of your adult children, or, perhaps their spouse, and wondered what in the world will become of your IRA when your child inherits it? Will the retirement asset you painstakingly built over 30 or 40 years disappear within 14 to 17 months, reported to be the nationwide average time for inheritance loss? A way to avoid that has been available for several years now. But in light of the U.S. Supreme Court’s new ruling, that tool, the “Stand-Alone Retirement Trust,” just became even more valuable!
Your own traditional IRA is subject to pre-age-59½ withdrawal penalties and post-age-70½ annual required minimum distributions (RMDs) and taxation. But when you die, your non-spouse beneficiaries of any age, must take out distributions from inherited IRAs, either within five years of your death or over their own remaining life expectancy under IRS tables. This enables the inheritors to “stretch out” the taxable RMDs over a longer time span, allowing the money to continue to grow tax-deferred.
The mathematical result can be astounding. But, amazingly, adult child beneficiaries usually pick the five-year plan (or even cash out entirely!), wasting the tax deferral benefits and spending the withdrawals, often to their later regret.
What was the alternative to protect them from this weighty decision forced upon them suddenly in a time of grief and without financial training? You might automatically think of the world of trusts. But until the last several years, the IRS made it difficult for a trust to be an IRA beneficiary and get both of two benefits: first, qualification for maximum tax stretch out using each primary beneficiary’s own life expectancy, and second, achieving the higher level of asset protection afforded by a trust that may accumulate the RMDs and hold them in new investments until future distributions.
Thankfully, laws changed, and the Stand-Alone Retirement Trust could be developed, allowing both maximum stretch out and asset protection benefits simultaneously. The decision whether to use this tool for retirement accounts over about $100,000 has been called a “no brainer” by many.
Specific benefits include, among others: since the trust is the named IRA or 401(k) beneficiary, no court guardian is needed for minor or incapacitated beneficiaries; beneficiaries are prevented from “cash me out, pay the tax, and spend the rest”; monies are protected from creditors, predators and ex-spouses; monies can be accumulated and doled out according to your plan; advantages for special needs beneficiaries; and you can name the successor beneficiaries in the trust and control who receives if your initial beneficiary dies (e.g., you can name your children from a prior marriage to receive after your current spouse dies, instead of allowing your spouse to be influenced into choosing the beneficiary). These should be separate trusts designed specifically for this purpose, thus the name “stand-alone.” Because both the trusts and IRA beneficiary designations must comply technically with IRS rules, an attorney with expertise in this area should be utilized.
Now, back to our headline. If these reasons weren’t enough, in June yet another incentive for Stand-Alone Trusts was born of national news: the U.S. Supreme Court unanimously decided the “Clark v. Rameker” case, holding that an inherited IRA is NOT exempt in the inheritor’s bankruptcy (unlike an IRA created of one’s own making). Result? Absent your preventive action, your lifetime of savings and growth can be “Poof! Gone!” in a blink if your IRA beneficiary found herself in a liability situation, whether created from her own mistake or from unavoidable or innocent circumstances. Prevent that with a Stand-Alone Retirement Trust!
You’ve worked years to accumulate your tax-deferred plans. Naming the right beneficiary—a special, separate trust, instead of individuals—can preserve and continue the tax-deferred growth long after you’re gone, protect the assets from creditors and the courts, and provide for your loved ones the way you want. What are you waiting for?
Debbie J. Papay and Chris E. Steiner, attorneys, together have over 65 years of experience with trust planning. Bayer, Papay & Steiner Co., LPA, Maumee, Ohio; call 419-891-8884.