Posts in category: Estate Planning Drafting Software

Today I will conclude our five part series on the five threats to qualified accounts. In our first four blogs we outlined the threats to IRA’s from income taxes, excise taxes, long-term care costs, and estate taxes.   Today we will focus on the final threat, the risk of loss to beneficiaries and/or their creditors.  The U.S. Supreme Court in June 2014 in Clark v. Rameker held an inherited IRA is not a “retirement account” for purposes of the protection under the Bankruptcy Code.  This threw the financial and estate planning industry into turmoil, but those of us who stayed abreast of the legal arguments, were not surprised by the courts decision had planned that way for many years.  A second and often overlooked threat is by the beneficiary themselves.  Not all beneficiaries are equipped to receive assets and properly manage or protect them.  So let’s look at these dangers more closely.  

As outlined in our first part of this series, qualified funds are inherently protected under ERISA and the Bankruptcy Act.  The challenge however, is the U.S. Supreme Court now has ruled inherited IRAs (the IRA after the death of the owner) is not protected.  This is a major threat to qualified accounts.  The most strategic way to protect against this threat is to ensure an individual's IRAs is beneficiary designated to a "see through” asset protection trust.  For a trust to be qualified as a designated beneficiary under the Internal Revenue Regulations it requires it is irrevocable at death, it is valid under state law, the beneficiaries are "identifiable" and a copy of the trust is provided to the plan administrator.  Once these four conditions are met the IRS will look “through” the trust at the beneficiaries of the trust to determine the designated beneficiary to determine the required minimum distributions.  This can be an exceptional planning tool to protect the qualified account from the reach of the creditors, divorce, lawsuits, nursing homes, or other predators of the beneficiary, who now owns the IRA.  For a complete review of using a trust as a beneficiary of an IRA and all its benefits register for our FREE ­­­­ Clark v. Rameker Webinar.

The second major risk to qualified accounts is that while we can protect the IRAs from the predators and creditors of the beneficiary, we cannot protect it from the beneficiary them self.  How often do professionals get the call from the child, that inherited an IRA who says, “I need $70,000.00 out of my inherited IRA”, then the advisor discovers it is to buy a $50,000.00 car ($20,000.00 needed for income taxes) that's worth $40,000.00 when it’s driven off the lot.  For individuals who are concerned about spendthrifts as beneficiaries, qualified accounts can be protected from abuse by the beneficiary themselves by creating an accumulation trust as beneficiary.  An accumulation trust allows the trustee to hold the IRA required distributions made from the IRA in the trust and are not required to be distributed out to the beneficiary.  This would typically be done if there's a risk of the distribution being lost to the beneficiary’s creditors or predators.  The principal argument against accumulation trusts is that the income not distributed is taxed at the higher trust tax rate.  True, but the question becomes would you rather pay the highest trust income tax rate of thirty nine point six percent or give it to a beneficiary who is subject to a judgment in which case the beneficiary would receive zero.  In addition, to avoid the higher income tax, the distributions would be made to other beneficiaries named in the trust.  So planning to protect an IRA from your beneficiaries and for your beneficiaries is not difficult, but does require planning during the life of the IRA owner to ensure the beneficiary does receive the qualified account outright but through the form of a trust which sets all the protections the client desires. 

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David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center

IRA’s and other qualified accounts are becoming the biggest portion of many individuals' portfolios.  They have many special rules to maintain their income tax advantages and despite having special rules that protect them for income tax there are several threats to them that are often overlooked by individuals and the professionals that serve them.  This will be the first of a five-part series sharing the five major threats to IRA’s and other qualified accounts and how to avoid them.  So what are the five major threats to retirement plans?  In my experience it is: income taxes, excise taxes, long term care costs, estate taxes, and risks to beneficiaries and/or their creditors.

The first risk to IRAs, and other qualified assets, is income taxes.  Many of us are aware contributions made to a qualified plan defers the income tax on the money contributed.  In addition, contributions accumulate "tax free".  The challenge and threat however is not upon the contribution to the plan, but the withdrawal.  The presumption is the individual will withdraw the money at retirement when they are in a lower income tax bracket.  That is not always true.  There is a risk the individual can have a higher tax bracket after death, or that income tax rates will rise (Congress has raised rates many times in the past).  Higher income tax rates later are not only caused by Congress and by the asset mix of the client, but quite often the income tax rate of the beneficiary is higher than that of the original plan owner.  For example a client in retirement might be taxed at the fifteen percent tax bracket but they pass away and leave it to their children, who may be in the thirty nine and a half percent tax bracket.  This is often overlooked. 

The biggest threat I find however, is that many individuals who own IRAs and retirement funds, only withdraw the required minimum distribution rather than optimizing the minimum income tax overall .  In many circumstances, seniors pay no income tax or only pay ten or fifteen percent.  A married couple over the age sixty five can earn up to $21,850.00 (not including social security) without paying any tax and up o $40,300.00 before they are subject to taxes beyond fifteen percent.  But seniors routinely take the required minimum distribution rather than taking more distributions to withdraw the most possible while keeping them in the fifteen percent tax bracket or less.  The biggest advantage is the after tax money (which only between zero and fifteen percent was paid) reinvested grows and is subject to capital gains rates which is lower than ordinary income tax on an IRA if ever sold during life, and if held till after death gets “stepped up” and no income tax is paid on the growth of the assets by the kids that inherit them, If the kids hold onto them all growth is subject to capital gains rates rather than the higher ordinary income tax rates.  So the alert to all is don't be on autopilot, examine your short and long term income tax rates compared to your beneficiaries, to properly decide when to take advantage of strategic distributions during life to ensure you pay the overall lowest income tax on your IRA’s.

Stay turned for Parts 2-5 and subscribe to our blog if you're not already (just enter your name and email on the box to the left).  If you would like to learn more about protecting IRA's after Clark v. Rameker join our FREE WEBINAR this Friday at 1 EST.  Click here to register.

David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center