When an IRA Isn't an IRARetirement Funding Estate Planning
One would think that an IRA would always be an IRA. But that isn't always the case and it can become a critical point if creditors "come a knockin".
A creditor can be someone that loaned you money. A creditor can also be someone that wins a lawsuit against you. If you don't pay the money owed, the creditor may go to court to try to get paid by forcing you to give him or her your assets.
Retirement accounts are specifically protected from creditors. Employer plans generally are completely protected. In most cases at least $1 Million in IRA's is protected from creditors. It is possible that an IRA could be protected for more the $1 Million if the funds in the IRA came from a rollover from an employer plan and/or depending on state law.
So, for most of us, the funds in our IRAs and retirement accounts will be protected. There is a catch though (or there wouldn't be much of a reason to write this article). In a court case not too long ago, the court decided that an inherited IRA was indeed not an IRA. The logic was that the funds were not invested for the retirement of the beneficiary and therefore were not protected from creditors. This brings up two possible scenarios.
- You inherit an IRA from one of your parents or someone else. The funds in the IRA will not be protected from creditors. That may not be a huge deal, especially if you have adequate liability protection through an umbrella policy. But if you're in a profession where you are likely to be sued (doctors would be one group that comes to mind), then you might want to look at asset protection techniques. Most likely, this will involve trusts and may accelerate your distributions and potentially increase the tax burden on the distributions. That may be worth it, if you're concerned about liability. If you think you may need to do this, consult with an attorney that specializes in asset protection.
- If one of your parents passes away and your surviving parent inherits the IRA, it is unclear how the courts would treat the IRA with regards to asset protection. Fortunately, a surviving spouse can set up the inherited IRA in his or her name and it is no longer is an inherited IRA. I think, but I'm not sure, that this would increase the level of protection of the assets. To be sure, consult with an attorney. But before you do that, make sure you look at other issues. For example, if the surviving spouse is younger than 59 ½ and will need the funds from the IRA now, then transferring the IRA funds to an IRA in the surviving spouse's name may not be a good idea. If there is a large age difference between the spouses you'll want to take a look at Required Minimum Distributions too.
I am convinced that IRAs are the single most complicated financial "tool" out there from a tax perspective. Be very careful when money is in movement (rolling over, transferring ownership) and an IRA is involved.
If you enjoyed this article, you might like the following blog posts:
Inherit the Family Home? Tax Consequences for Military Officers
The Tax Bomb Waiting for Retiring Military Officers
Military Finances 101: Retirement Accounts