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How Much Is Too Much to Protect Your IRA for Your Heirs?

How Much Is Too Much to Protect Your IRA for Your Heirs?

You want to do a good thing, leave your loved one not only memories, but money too. However, if your plan is to have them inherit your IRA, it could be costly, if that loved one is someone other than your spouse.

In June the U.S. Supreme Court ruled in Clark v. Rameker, that inherited IRAs are not "retirement funds" within the meaning of bankruptcy law. The translation: they are up for grabs by creditors.

The court distinguished inherited IRAs from a participant-owned IRA because it took into consideration the fact that when you inherit an IRA you can’t make additional contributions, you also must take required minimum distributions no matter your age, and when you inherit an IRA you can withdraw all the money when you want, without penalty. Such rules certainly don’t apply to participant-owned IRAs. The Supreme Court essentially turned positives into negatives.

There are however ways to protect an inherited IRA. The question though, is whether it’s worth doing and what’s involved?

Here are some key considerations

"In the wake of the Supreme Court decision, those that plan to name anyone other than their spouse as their IRA’s primary (or secondary) beneficiary need to consider more sophisticated estate planning arrangements," says ReKeithen Miller, a certified financial planner with Palisades Hudson Financial group.

The most common of which, he says, is having a trust serve as the beneficiary of the IRA. "Naming a trust as your IRA beneficiary is essentially an insurance policy that protects your IRA assets from going to benefit the likes of Visa or MasterCard, instead of your family members," says Miller.

"In the wake of the Supreme Court decision, those that plan to name anyone other than their spouse as their IRA’s primary (or secondary) beneficiary need to consider more sophisticated estate planning arrangements."
-ReKeithen Miller

However, you have to weigh the extra protection of a trust against the work and expense of setting up and administering it. Trusts are not cheap. Though costs vary, "To set one up you can expect to pay $3,000-$10,000 in legal fees. There are administrative expenses which can be $2,000-$4,000," says Dean Hedeker, a CPA and attorney with Hedeker Wealth Management Group. Then there is the annual cost to file the trust’s tax return.

There are other concerns besides cost. Choosing the right structure is a challenge, if you’re not being guided by a knowledgeable estate planning attorney or financial advisor. "In order to get all the tax benefits of an inherited IRA coupled with a trust must be a so-called see-through trust, in which the beneficiaries are identifiable under the IRS rules," explains Hedeker.

If there are no identifiable beneficiaries, the IRA funds would have to be withdrawn within five years of the last day of the year the IRA owner died, assuming the IRA owner was younger than 70 ½ years old. If the IRA owner dies at that age, or older, the withdrawals may be based on what would have been the IRA owner’s remaining life expectancy, explains Hedeker.

If the trust isn’t set up as a see-through trust, there could be tax implications. In a non-see-through trust, annual income after the first $12,149 is taxed at the top rate of 39.6%. Income generated in a see-through trust, though, is taxed at the beneficiaries’ individual rate, which probably are a lot lower, says Hedeker.

How else can you protect your heirs?

If trusts sound complicated, they can be. For sure you want good help. There are some other ways to protect your IRA from creditors. Check out the laws in your state. For example, in Ohio, bankruptcy exemption statutes shelter inherited IRAs, points out Chad Lahrmer, CPA and founder of Lahrmer & Company. Other states that have adopted laws expressly exempting inherited IRAs under state bankruptcies include Alaska, Arizona, Florida, North Carolina and Texas, says Mike Kilbourn, author of Disinherit the IRS.

Another strategy says Leonard Rankin, a financial advisor with Park Avenue Securities, "is to withdraw a portion of the IRA while you are alive to buy life insurance on the lives of your children or yourself. After death, when the proceeds are paid, they are creditor proof from the creditors of the heirs in just about all states. Additionally, these funds can be paid to trusts where they would not only be protected, but could also be exempt from estate and inheritance taxes forever."

The bottom line, says Miller, "You have to weigh the extra protection of a trust against the work and expense of setting up and administering it. Establishing a trust and maintaining it can easily cost several thousand dollars a year. If your IRA is only a few thousand dollars, a trust probably isn’t worth the hassle. That’s like paying your auto insurance company premiums to cover a Ferrari when you drive a Ford Fiesta."

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Anonymous   |     |   Comment #1
Why on earth I would like to leave my hard earned savings to the heirs. Isn't the whole point of savings to be used in retirement time?
You are suggesting to deprive myself and my present needs, just to leave the money to someone else. If you are rich and do not need the money it is a different story, but our normal people need every penny in retirement time.
I personally will try to leave as least as possible, I need the money more than anybody else after me, after all that is not greed, it is a logical and practical decision.
Anonymous   |     |   Comment #3
Giving and donations for "good" is a nice endeavor, too!
Anonymous   |     |   Comment #6
If the purpose of IRA was to give it away, why create it on first place, give away the money as you go through life. IRA was built from sacrifices and savings and depriving yourself of better life style in the working years.
Anonymous   |     |   Comment #2
Or, dont owe money to creditors.
Anonymous   |     |   Comment #4
As it should be.  An inherited IRA was not the heirs own personal retirement account.  If the heirs owe money to creditors there is no reason why the money in an inherited IRA should not go to pay off their debts.

The same goes for elderly giving away real estate and other valuable assets to other family members, leaving us tax payers holding the bag to pay their Medicaid   bills.  The official "look back" should be extended from the present five years to eight or ten years.
Anonymous   |     |   Comment #5
Make sure "you" don't claim Soc Sec benefits, or unemployment benefits, corporations don't claim proper deductions, etc. so that "you" can pay as much taxes as possible....

PS.  Therefore funds will be available for those eligible for same AND will find them there!  Work within the laws.  But if "you" are entitled to ______ and want to forgo same, go for it! 

PPS  Perhaps a 100% estate tax is needed to ensure "everyone works?"
Anonymous   |     |   Comment #7
"PPS  Perhaps a 100% estate tax is needed to ensure "everyone works?"

Good point!  When you're dead you have no further need of it but the Federal government always needs more.  Then they can give more to the people who don't want to work.
Rosedala   |     |   Comment #9
I collect Social Security as a senior...what are the implications I might have to face?  But if you are talking about AFTER death...Nothing can be done can it?  I think I don't follow you.  I'm interested, care to explain?  Thanks.
Rosedala   |     |   Comment #8
"...leaving us tax payers holding the bag to pay their Medicaid   bills."

How do you figure this?  Thanks.
Anonymous   |     |   Comment #11
Medicare and SS are pyramid schemes that basically make the young pay for the retirement & healthcare of the old. As a worker I pay a lot more in medicare taxes than any medicare recipient pays in premiums so a get a laugh each year thst seniors gripe about the medicare premium going up.
Rosedala   |     |   Comment #12
Wow!!!  I'm surprised to read your sarcastic and bitter message!!!  I paid for Medicare AND Social Security during my entire working life!!!  (Never under-the-table-salaries or other payments).  And so all others have.  AND so YOU will collect IF you've paid them while you worked.  Pray, what makes you THIS enraged???  I'm curious...        :o(
Anonymous   |     |   Comment #14
Rosedala, there in no longer trust fund for SS or Medicare, it was raided by the democrats, the money for the benefits come from the treasury general fund and we all contribute to it now, yes all of us even the people on SS or other benefits who are liable for tax every year.
alpha   |     |   Comment #15
Did the Democrats burn down your house or something? Get over the partisanship - that fund was "raided" by both parties.
Anonymous   |     |   Comment #13
I could understand some not having first hand knowledge of the Depression but the recent "Great Recession" just reminds everyone that everyone can't be a winner in the investments of life. 

BTW, how many availed themselves of "walking" from a loan used to purchase a home to live in, i.e. not as an investment nor an home equity type loan?  Several states (started during the depression and continues) provided that such a homeowner can "walk" and have no personal liability (another reason to at least initially have a "purchase money loan" on a residence).  How many refinanced those original loans and were not told by the lender that the new loan would be WITH personal liability?  And, if an earthquake comes (are you living in a fracking area?), walking is the "best" insurance policy for same...for some in those states.

One availing themselves of properly enacted provisions of law is what the legislatures intended.  If one does not avail themselves of same, shame on them and it is unfortunate for their loved ones!
Rosedala   |     |   Comment #10
I say, THANK YOU Sheryl Nance-Nash AND KenTumin for all the most useful articles, beyond and above the very valuable reporting by Ken Tumin of the Best Rates and Deals!  Kudos to both.  Keep them coming please!!!    :o) 
Anonymous   |     |   Comment #16
Another article telling us how to avoid paying creditors (people we owe money). Inherited IRA's should be cashed out, taxes paid, creditors made whole and then, and only then, distributed among beneficiaries. Spousal inheritance (IRA transfer) would still apply.
Anonymous   |     |   Comment #17
Can an inherited IRA (non-spouse) be rolled into an IRA of the recipient?
Anonymous   |     |   Comment #19
No. I believe only a spousal IRA may be rolled into the recipient's IRA.
Anonymous   |     |   Comment #20
Could you expand...spousal IRA may be rolled into recipient's...who is the recipient in your example?  the spouse?

Soooooooo, are you saying that an inherited IRA by a non-spouse cannot be rolled into another IRA  of that same non-spouse recipient? 
Anonymous   |     |   Comment #21
Only a spouse has the option of moving the money in the IRA to the inheriting spouse's own IRA. (The spouse also has the option of having the passing spouse's IRA retitled with the surviving spouse as the beneficiary.)

Any other beneficiary (a non-spouse) is not able to move the inherited money from the original IRA to his or her own IRA. The original IRA is retitled for the benefit of the inherited.
Anonymous   |     |   Comment #22
You said,"Any other beneficiary (a non-spouse) is not able to move the inherited money from the original IRA to his or her own IRA"  One can always move IRA money.  Thus, if so, the inherited person changes the name on the IRA to reflect his/her ownership, and then moves/rollovers to another trustee, eg, and thus that inherited IRA is solely in the name of the person that inherited.  Right?  And, if so, wouldn't that "new" IRA be protected, then?
Anonymous   |     |   Comment #23
By move the inherited, I mean moving the money from the inherited IRA to one's own IRA. That may not be done. However, the money can be moved from one trustee to another trustee by a direct transfer. However (again), the name on the inherited IRA may not be changed.

This is from IRS Pub 590 page 22. This rules seems to apply to inherited Roth IRAs as well.
"Inherited from someone other than spouse.
If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA. However, you can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary."

To answer your questions, then, the first answer is no because this may not be done. The answer to the second question would be no as well.
Anonymous   |     |   Comment #24
Got it!  Very good, thanks!
Anonymous   |     |   Comment #18
I agree with you, #16, 100%.

There is no reason why people who come into a substantial inheritance should not repay their creditors first.  Just another example of shirking their personal responsibility.  And they don't need any more articles advising them how to keep from repaying their debts.