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Clark v Rameker – Protecting IRAs

In June, the US Supreme Court ruled in Clark v. Rameker that inherited IRAs will not be protected in bankruptcy.

Here is a brief summary of the case:

Mom established IRA in 2000 and named her daughter as beneficiary. Mom died in 2001. In 2010, daughter and her husband filed for bankruptcy and tried to exempt daughter’s inherited IRA, worth $300,000, from the bankruptcy estate. The US Supreme Court, in a rare unanimous decision, ruled that an inherited IRA is not a “retirement fund” and, therefore, is not an exempt asset in bankruptcy.

What if you want to protect your IRA for your children from bankruptcy?

The best way to protect your IRA for your children is to use a trust. Under the Bankruptcy Code, an inherited IRA that is controlled by a trust will be excluded from bankruptcy and would not be subject to the ruling in Clark v. Rameker. There are two ways to use a trust with your IRA:

1. Name a sub-trust of your revocable living trust as the beneficiary of your IRA, or

2. Create a Stand Alone Retirement Plan Trust and name it as the beneficiary of your IRA.

Naming a sub-trust of your revocable living trust as beneficiary requires your living trust to include sub-trusts. A sub-trust is a separate trust that is created for the benefit of your child when you and your spouse pass away. We often refer to these as “inheritance protection trusts.” For almost all of our clients, we recommend including inheritance protection trusts in their revocable living trust to better protect their children’s inheritance from lawsuits and divorce claims.

The problem with naming sub-trusts of your revocable living trust as beneficiaries of your IRA is that the trust may not qualify for stretch-out treatment, and if not, the IRA would have to be paid out in five years. This would negate the IRA’s main benefit of tax deferred growth.

The better solution is to use a stand alone retirement plan trust. This is a trust separate from a revocable living trust. It has a singular purpose to be the beneficiary of an IRA. Because of its singular purpose, it will more easily qualify for stretch out and allow your children’s inherited IRA to be significantly protected from lawsuits, divorces and even bankruptcy.

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