Retirement plans such as 401(k)s and IRAs (Individual Retirement Accounts) are protected from creditors during bankruptcy, but are they safe from creditors after your death? This is the question that thousands of people have been asking.
IRAs are rapidly becoming the most popular method of saving for retirement, as they are a safe form of investing assets. The following article shall answer the pressing question “Are Inherited IRAs safe from creditors?”
Bankruptcy and Retirement Accounts
Similar to Social Security benefits and 401(k), IRAs are protected in the event of bankruptcy proceedings. If you were to ever declare bankruptcy, the assets that you hold in your IRA cannot be seized by creditors. Keep in mind that this does not apply to IRS (Internal Revenue Service) levies, civil lawsuits and other kinds of judgements. In certain states, IRA assets may in fact be protected from creditors, but this varies from one state to another.
Both Roth and Contributory IRAs have a $1 adjustment limited inflation which is specified in the protection rules for federal bankruptcy. This limit does not apply to those IRAs that contain assets that have been rolled over from a qualified plan (401(k), so this means that they are completely protected.
What about Protection for Beneficiaries?
With an IRA, you have the ability to choose a beneficiary (or beneficiaries) to which you would pass on your assets after your death. IRAs are great estate planning tools as they provide that your assets will not be held in probate before being passed to your designated beneficiary or beneficiaries. They are an ideal means for ensuring that your estate plan will be carried out according your exact terms and specifications.
Of course, this will require some detailed planning on your behalf. IRAs and estate plans ensure that you will have complete control over the transfer of wealth of your retirement funds. This is a legal and binding document and holds true even in the event that you have do not have a will.
In most cases, those who are non-spouse beneficiaries of IRAs are not offered the same protection from creditors. Unlike the original account holder, these assets will be subject to bankruptcy hearings and thus could very well be seized, per a United States Supreme Court Ruling. The reasoning behind this is that since the original IRA owner is now deceased and the funds/assets have been transferred to the beneficiary, they are no longer to be considered as retirement funds. Keep this in mind when you are choosing a beneficiary for your IRA.
A non-spouse beneficiary is not able to commingle funds. This means that they are unable to place the inherited IRA funds or assets in their personal retirement accounts. However, if the spouse is the designated beneficiary, they may roll over, or transfer, the IRA asset in their personal account, which means they are protected from creditors and bankruptcy proceedings.
How can Beneficiaries Be Protected?
If the designated beneficiary of an IRA is their child and that child then has issues with debt or other financial difficulties, this could present a dilemma.
One way to prevent this from occurring is to establish a conduit trust on which the trustee is designated as the beneficiary rather than the child. If drafted correctly, the trust is then protected from bankruptcy and creditors. Also, the offspring will still be able to benefit from the inheritance.
In this instance, the required minimum distributions of the IRA are then calculated per the life expectancy of the trustee and thus taxed at their tax rate. Since the beneficiary does not legally own the assets, they are now protected. A key point to remember is that the income will no longer be protected once it has been paid out to the beneficiary.
As a rule, you should review your IRAs periodically to ensure that everything is up to date. As well, take note if your beneficiaries are experiencing financial difficulties. If this is the case, you might want to name a new beneficiary to protect the inherited assets.
Remember that the laws differ by each state. Talk with your estate planner or tax attorney to find out the current laws in that state in which you are currently residing.