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A recent United States Supreme Court decision will change how Inherited IRAs are treated for bankruptcy and asset protection purposes: Upon the death of the original IRA participant, the IRA benefits the named beneficiary.

The United State Supreme Court decision on June 12, 2014 determined that Inherited IRAs are not “retirement funds” and are not entitled to the same bankruptcy and creditor protections afforded to participant-owned IRAs.

Prior to this recent decision, inherited IRAs were treated similarly to participant-owned IRAs – they were considered “retirement funds”. As such, these IRAs were not available to satisfy creditors’ claims, according to federal bankruptcy code.

The court’s decision was based on three factors:

  1. Inherited IRAs prohibit additional contributions
  2. An Inherited IRA owner can liquidate the entire account without penalty
  3. An Inherited IRA owner must withdraw all account funds within five years or take required minimum distributions.

The Court concluded that inherited IRAs do not serve the intended purpose of an IRA: to provide money for the original participant’s retirement. Therefore, Inherited IRAs are not entitled to the same creditor protection.

This means that the Court’s three-factor test can be applied to all inherited defined contribution retirement plan accounts, including inherited 401(k) and 403(b) accounts.

This ruling could have serious implications on estate plans, as certain retirement assets earmarked for beneficiaries will no longer receive creditor protection. No one wants their carefully planned estate planning decisions to be subject to a court’s factor-based decision. One way for you to increase certainty regarding your estate plan and insure that your retirement funds will remain protected for future generations is to consider using a Standalone Retirement Trust.

A Standalone Retirement Trust, when drafted properly and created at a time when the IRA participant is not at risk of creditor’s claims, has several advantages over outright distributions. The most significant advantage of a Standalone Retirement Trust is the ability to protect the funds in the inherited IRA from a beneficiary’s creditors. A Standalone Retirement Trust can also be tailored to the unique needs and situations. For example, a client may take advantage of the inherent benefits of a trust and include provisions limiting distributions, selecting an experienced professional trustee or providing for special needs beneficiaries.

There are significant estate planning consequences for Inherited IRAs. It is important to consider the retirement assets in your estate plan and determine whether these assets will remain protected.

The Estate Planning Team at Anthony J. Madonia & Associates, Ltd. can assist you with this process and help you determine whether a Standalone Retirement Trust is the best option for your estate plan.

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