On June 12, 2014, a watershed decision was handed down by the U.S. Supreme Court that affects almost all of our clients. The question answered was whether or not IRAs that are inherited by children would be protected from their creditors in the same way they are protected when owned by their parents.
Over the past half dozen years, Texas and other states have grappled with this question. In Texas, there were appellate courts providing varying conclusions, and then we thought the answer was provided by our legislature in a recent revision to our statutes. Nonetheless, due to the varying decisions within the states on this topic, the U.S. Supreme Court stepped in to decide the issue, which looms large as baby boomers leave this substantial part of their estates among their children.
The U.S. Supreme Court’s conclusion was that inherited IRA’s are not protected under the Federal bankruptcy law exemptions when received outright by children in their own names. However, depending on the residence of the debtor, he or she may be able to select state law exemptions to protect an inherited IRA, but this option varies by state and may eliminate the debtor’s ability to take advantage of other more advantageous Federal bankruptcy law exemptions.
At Dismuke & Waters, we have been recommending for years that the only way to effectively protect these assets is to have a trust prepared with the proper language to receive the monies and make sure the beneficiary designations fund those trusts. The variance in the law between the states on this topic and the transience of our clients and their children made this the most logical answer.
Until this decision by the U.S. Supreme Court, however, financial institutions have been spotty in their flexibility to accept good, clear beneficiary designations, which would properly fund these trusts without giving up any ability to stretch the inherited IRA. The institutions have historically provided limited space to make designations, only permit completion of the forms on-line, or simply refuse options that do not fit the options that which they decide are appropriate. Hopefully this decision will encourage more consistent and flexible forms from banks and the brokerage community to allow clients the ability to take advantage of the protective features of the children’s trusts they have incorporated into their estate plans, with the assistance of experienced legal counsel.
In conclusion, we would advise that you check to make sure your IRA beneficiary designations do not specifically name your children if you wish for those assets to be protected from their creditors. In addition, if the trust that has been prepared to receive your children’s inheritance does not extensively deal with IRAs and how to keep them protected while at the same time stretching income tax recognition for as long as possible, we would encourage you to call or schedule an appointment to visit with us so we can work with you to make sure your trust, IRA and the beneficiary designation work hand in hand to accomplish your goals.