Helping Your Clients Safeguard Their Assets

The Supreme Court’s 2014 ruling in Clark v. Rameker (2014) had a rippling effect on the financial planning industry and the way advisors address IRA beneficiary designations. The ruling determined that inherited IRAs are not “retirement funds” under federal bankruptcy law, which means that, unlike with retirement accounts, these assets are accessible by potential creditors. This precedent-setting decision continues to have a meaningful effect on estate planning strategies for IRAs.

To guide you through this area of asset protection planning, I’ll discuss the impact this ruling has had on trust planning and IRAs, as well as how you can help your clients safeguard their assets and accomplish other estate planning objectives.

The Supreme Court found that inherited IRAs do not constitute protected retirement funds under federal bankruptcy law because the holder:

• Cannot make additional contributions
• Is required to withdraw funds from the account
• Is permitted to withdraw the entire balance of the account at any time without penalty

In light of this, a surviving spouse who inherits retirement benefits is left with two options:

• He or she could elect to treat the inherited IRA as his or her own, in which case the traditional IRA rules would apply (e.g., the holder may make additional contributions, the holder is subject to a 10-percent early withdrawal penalty), and the asset would be protected.
• The spouse could leave the asset as an inherited IRA, but it would not be considered a retirement fund and, therefore, would be left vulnerable to creditors.

Beneficiaries who are not surviving spouses have even fewer options; they cannot treat an inherited IRA as their own, but rather must leave it as an inherited IRA or take a lump-sum distribution.

Given this potential risk, how can you help your clients ensure that their assets are in a position of safety?

One option your clients can use to protect their beneficiaries from creditors is to name a trust as a beneficiary. Correctly drafted trusts have long been effective in accomplishing planning strategies, including:

• Creditor protection (for the grantor and the trust beneficiaries)
• Divorce planning (for mixed families or children)
• Spendthrift protection (to control a beneficiary’s access to funds)
• Special needs planning (to protect a beneficiary's right to government benefits)
• Planning for minor beneficiaries (to control distribution of assets without the use of a guardian or custodial account)

To implement these planning strategies most effectively, it’s important that you and your client discuss:

• How to balance the required minimum distribution (RMD) options available to the trustee
• Related income tax considerations for the beneficiaries
• Ability to provide asset protection

Using trust planning and IRAs to accomplish your clients’ goals requires multifaceted consideration of interests that are often competing. To better understand the options available, let's examine how different kinds of trusts benefit certain estate planning objectives.

If the trust satisfies the IRS see-through trust rules, the trustee may take RMDs over the life expectancy of the oldest individual beneficiary. One of the primary requirements is that all of the trust beneficiaries must be identifiable individuals.

In contrast, if individual beneficiaries are directly named as the IRA beneficiary, they may set up their own IRA beneficiary designation accounts for their shares and take RMDs over their own life expectancies.

It's important to note that a see-through trust can’t exercise the spousal rollover option. For example, if a surviving spouse is the income beneficiary with children as remainders, upon the surviving spouse's death, the trust must continue its RMDs based on the surviving spouse’s life expectancy. As a result, the IRA assets will be consumed more quickly.

Although the IRS RMD rules govern the timing of distributions from an IRA to a trustee, the timing of when assets are distributed from the trustee to the beneficiaries depends on the kind of see-through trust in place. Let’s explore the two most common types: conduit trusts and accumulation trusts.

Conduit trusts. A conduit trust is a safe harbor see-through trust in which the primary beneficiary is the only recognized beneficiary for RMD purposes.

• The trustee must distribute all RMDs to the beneficiary as soon as he or she receives them from the plan.
• There’s no authority for the trustee to accumulate plan distributions in the trust.

As the trustee must distribute all plan distributions, these assets are not subject to the trust’s higher tax rates. Despite the income tax advantages, the lack of trustee authority to accumulate plan assets does not support planning for a client whose primary goal is asset or spendthrift protection.

Accumulation trusts. These trusts are not safe harbor trusts and may or may not satisfy the see-through trust rules.

• This kind of trust provides the trustee discretion to accumulate plan distributions inside the trust, rather than distributing immediately to the beneficiaries.
• Some or all of the potential remaining beneficiaries will be included under RMD rules.
• For stretch purposes, RMDs are distributed over the life expectancy of the oldest beneficiary.

Also, assets that are retained in the trust may be afforded creditor or spendthrift protection for:

• Beneficiaries and their descendants from potential claims resulting from divorce, poor financial management, or other situations
• IRA beneficiaries who live outside of states that have exemptions for inherited IRAs

Because the trustee is not required to pay out the full plan distribution to the beneficiaries, it’s important to analyze the impact of trust income taxation. Amounts remaining in the trust may be taxed at a higher tax rate. Another downside to having the IRA payable to an accumulation trust is that the surviving spouse cannot treat the IRA as his or her own.

Considering the Supreme Court’s decision, the complexity of the IRS RMD rules, and the complicated tax concerns for trusts, many attorneys now recommend the use of a stand-alone trust. This trust comes in many forms, including conduit and accumulation trust provisions. But, as the name suggests, the stand-alone trust is a separate trust document:

• Planning for IRA assets is kept separate from the client’s other estate planning objectives, minimizing the risk that these objectives will interfere with the IRS RMD rules for retirement benefits (and vice versa).
• The stand-alone trust will offer total separation from any other assets held by the decedent upon his or her death.
• A well-drafted stand-alone IRA provision can meet the requirements of a designated beneficiary trust and likely will be easier for the custodian and trustee to read, understand, and implement.

The use of trust planning and IRAs is often challenging for clients to digest, and navigating IRS rules can be complicated. But a trust may make sense if asset protection is a high priority for your client, and a trust that incorporates the client’s other planning objectives is an even better bonus.

It’s important for your clients to work with an attorney if an IRA is anticipated to be a trust asset; an attorney can also help clients understand the potential consequences of leaving retirement funds outright to beneficiaries rather than to a trust. Your clients should discuss any competing goals with you before they decide on the appropriate beneficiaries for their IRA assets.

Are your clients using trust planning and IRAs to strategically safeguard their assets? How have you helped your clients achieve their estate planning objectives in light of the Clark v. Rameker decision? Please share your thoughts with us below.

Editor's Note: This post was originally published in July 2015, but we've updated it to bring you more relevant and timely information.