The Clark case, recently issued by the Supreme Court, has shaken the foundation of certainty that IRA accounts are exempt from the claims of creditors.
The actual holding in this case found that an inherited IRA worth $300,000, which was received by the IRA owner’s child through a beneficiary designation, was not considered a “retirement account” for purposes of the Bankruptcy Code. Therefore, the inherited IRA account was not exempt from the claims of the bankruptcy creditors. This new vulnerability of IRAs is a very important change since creditors, as the saying goes, “step into the shoes of the debtor” and have the same rights to liquidate an asset as the debtor does.
An inherited IRA is an IRA which is passed to a non-spouse individual by beneficiary designation and is paid out over the remaining actuarial life of the beneficiary, as measured from the date of death of the IRA owner. The beneficiary is required to withdraw the annual Minimum Required Distributions (MRDs), in a manner similar to the owner of a traditional IRA who must withdraw MRDs beginning in the year they turn 70 ½ years of age. If you think about your IRA, whoever is named as a beneficiary, other than your spouse, would potentially possess an inherited IRA (unless they decided to empty the IRA upon receipt, or within five years of the owner’s date of death). Inherited IRA’s are covered under §408 of the Internal Revenue Code.
Interestingly, Maryland law provides for “exemptions from execution” in the Courts and Judicial Proceedings Article of the Maryland Code (§11-504). That law specifically exempts retirement accounts listed in §408 of the Internal Revenue Code, among other sections. Therefore, one might reasonably feel as though the Supreme Court decision in the Clark case doesn’t apply to Maryland inherited IRAs. The problem, however, is that even if Maryland law is later ruled to exempt inherited IRAs from creditors, your IRA beneficiaries may not cooperate by remaining Maryland residents, enjoying the protection of Maryland’s laws.
Depending on how the various cases are resolved as they work their way through the courts, inherited IRAs may or may not be protected in Maryland. Regardless, non-spousal IRA beneficiaries may not remain in Maryland and enjoy the creditor protection afforded by the beneficial Maryland law.
One solution to this insecurity as to the asset protection covering inherited IRAs is to use a dedicated Standalone Retirement Trust (SRT). This type of trust will ordinarily be designed as a “conduit” trust so that the Inherited IRA MRDs will be payable to the trustee of the SRT, who will, in turn, make equivalent distributions to your named beneficiaries. Then, if your beneficiaries ever have a creditor, the creditor will only have those rights reserved to your beneficiaries in the trust document. Because your beneficiaries will only have the right to receive the MRDs, the creditor will only have the right to receive that one distribution per year. A “friendly” trustee can still be used to make large distributions to a needy beneficiary.
Without an SRT, the Inherited IRA beneficiary has the right to liquidate (empty) the IRA account. Therefore, that beneficiary’s creditor has the same right to empty the IRA account.
With an SRT, only the SRT trustee has the right to empty the IRA account and the SRT can be customized to provide more, or less, asset protection to the Inherited IRA beneficiary, keeping in mind that the creditor “can step into the shoes” of the debtor.