IRAs

Protecting Your Children by Protecting Their Inheritance

 

Providing Asset Protection for Your Kids

Providing an inheritance for one’s children is a common desire among the current generation of middle aged Americans. Protecting that inheritance may be something that many of us overlook when planning for the future. After all, the assets to be handed down represent a lifetime of work and careful stewardship; generations of family owned land or a family run business hold financial value as well as emotional ties that run deep. Knowing that this inheritance, once handed down to the children, could potentially be at risk through liquidation from creditors or poor financial habits of the beneficiary motivates good planners to put safeguards in place, preventing future loss.

Know The Number One Rule of Asset Protection: 

Your Kids’ Predators and Creditors Can Get Anything They Control

 

By crafting an individualized Trust with sound advice from a qualified Estate Planning attorney, the inheritance that you leave can be protected from risk of loss. This can assure that your heirs still receive the financial benefits of the inheritance but do not have full access to the assets. Typically this involves appointing a Trustee to hold title to the property for the benefit of your heir.

Example: A son inherits from his parents and the money is held in a Trust. His sister is the Trustee. The son wants to buy a lake cabin and asks his sister for the money. Instead of writing a check to her brother, the sister (Trustee) uses the Trust funds to purchase the condo in the name of the Trust.   This way, the son uses and enjoys the benefits of the condo but does not own title to it. The Trust owns the title to the condo. It would therefore, not become subject to any creditors or predators that could threaten the asset.  It does not become subject to claims of creditors and predators.

What are the Risks? Who are the creditors and predators?

Divorce

 

*Divorce: While technically inherited property is considered separate from marital property, once the assets are inherited without restrictions, they often end up in a common marital pool of ownership. For example, depositing cash into a joint bank account will cause the funds to be commingled. It may also be seen as granting title to the joint account owner. In 2015 alone, Oklahoma had over 21,000 divorce filings.

*Lawsuits and Judgements: In Oklahoma, more than 150,000 civil cases (individuals who were personally sued) were filed in 2015. A litigation target with protected assets is less attractive to an attorney because of the limited ability to collect from any civil law suit.  A trust can render a judgment noncollectable.

*Bankruptcies:  Personal bankruptcies are far too common.  Common causes are medical bills, uncontrolled spending, vehicle accidents and Bankruptcybusiness failures.

*Immature Financial Management Skills: Often a child with poor financial management skills who receives unearned income will be quick to part from the inheritance. Safeguards can be put into place to prevent a child from squandering an inheritance or making foolish investments with the money.

*Mental Health/Substance Abuse: About 4.1% of adults suffer from mental illness. Those with mental illness may lack the necessary skills to make good financial decisions putting the inheritance at risk without the intended benefit. Additionally, drug and alcohol abuse is at an epidemic level in our society. A Trustee can help insure that the inheritance is used to pay for treatment or other beneficial interventions and not being used to further harm a child that suffers from addiction.

*Special Needs: A child who has special needs such as mental or physical disabilities may become disqualified for government assistance like Medicaid or Veteran’s benefits should an inheritance be gained without the protection of a Trust. Careful drafting is required to insure that the trust property in not counted against the person with these challenges.

his hers ours*Blended Families/Remarriage: Many couples with blended families have similar goals. The first is to provide an inheritance for the surviving spouse. An additional goal is often that of insuring that the biological children as well as the step-children are assured the inheritance that is desired. An asset protection plan can protect the surviving spouse and the children from the loss of assets or disrupted estate plans.

*Remarriage: It is not uncommon for a widow to remarry. No estate planning can, or should, prevent this. However, the new spouse may cause assets ultimately intended for the children end up in their or their own kids’ hands.

You Didn’t Earn It for Them to Burn It

What can be done? Estate planning is more than generating documents. Involves counseling to meet the objectives of the client. Proper uses of trusts and other planning tools can insure that your intended beneficiaries receive and enjoy the full value of their inheritance.

Don’t Leave Your IRA to Your Kid Outright

IRA Broken ChainIRAs are wonderful investments.  Many people want to leave unused funds to their children.  They simply name their kids as a beneficiary and think that everything is set.  Many fail to understand that merely naming the children as beneficiaries may result in the loss in the value of the assets.  This occurs in two ways:

  1. An IRA inherited from is not a protected retirement asset.  This means that it may become subject to claims made by creditors, divorcing spouses and the bankruptcy court; and
  2. Many kids cash out the IRA and lose growth and tax advantages

Inherited IRA not Protected

While your IRA is generally safe from creditors and bankruptcy.  It might not be safe in the hands of your kids depending upon how it is left to them. In 2014, U.S. Supreme Court in Clark v. Ramiker 134 S.Ct. 2242 (2014) ruled that inherited IRAs are not retirement accounts for purposes of protection from bankruptcy and general creditors.

Heidi Clark inherited an IRA from her mother and began receiving the Required Minimum Distributions. Heidi and her husband ran into financial troubles and filed bankruptcy. They attempted to exempt the IRA from the bankruptcy. The Supreme Court ruled that although retirement funds are protected in the hands of the original owners, inherited IRAs are not. Since the IRA was in Heidi’s name the $300,000 became available to her creditors.

The implications go well beyond bankruptcy.  An IRA could be subject to claims by your children’s’ creditors and divorcing spouses.

A Trust Could Have Protected the IRA

Heidi’s result would have been different her mother named an asset protection trust as the beneficiary. The trust would administer the asset for Heidi’s benefit but Heidi would not be able to cash out the IRA or demand payments. Therefore, it would not be subject to bankruptcy, creditors or divorce claims.

Destroying Value by Cashing Out IRA, Stretch It Instead

Imagine being left a large sum of money and all you have to do is sign a form and you get all of it–or so you thought.  When an inherited IRA is cashed stretching moneyout any previously untaxed money that you take from the account will be treated as ordinary income.  Many people make this mistake.  Instead of taking the cash in a lump sum the person inheriting the IRA could elect to take the required minimum distributions (RMDs).  While there may be some taxes, the funds remaining in the fund can continue to grow tax-free.  This is knows as a Stretch IRA.

For example:

  • 50 year old
  • IRA worth $200,000
  • Earns 6%
  • Takes RMDs
  • Would receive total distributions of over $675,000.

Run your own numbers with this tool:  Click Here

Can I Make My Kid Take the RMDs?

If you just name them as a beneficiary the answer is no.  However, a Trust can be set up to take advantage of the stretch rules.  A trustee is named who can make the decisions.  If needed the Trustee can chose, but cannot be forced, to cash out the IRA.

Can I Use Any Trust?

Typical Revocable Trust:  A typical revocable living trust calls for distributions at the death of the person(s) who establish the trust.  These trusts offer no protection from creditors for the children once they receive the distribution and they are not designed to enforce the Stretch provisions.

No there are certain restrictions on the trusts and the beneficiaries of the trust in order to qualify for stretch requirements. This is sometimes called the “See Though Trust” rule

  • The trust must be valid under state law
  • The trust must be irrevocable or become irrevocable upon the death of the IRA owner
  • All beneficiaries must be identifiable and eligible to receive RMDs (naming a church or charity may destroy the plan).
  • A copy of “trust documentation” must be sent to the IRA custodian by October 31st of the year following the year of the IRA owner’s death.

Don’t Forget to Change the Beneficiary, Correctly

The Beneficiary Designation is critical.  A Will or a Trust might say what is supposed to happen with the money, but if the beneficiaries are not changed the document is useless.  The wrong choice may trigger the 5 year liquidation rule.

  • “My estate” – 5 year liquidation rule
  • “My children” – Oldest child’s age used to determine RMD
  • “My trust” – Oldest possible beneficiary in trust used to determine RMD
  • “My family trust” – Oldest possible beneficiary in family trust
  • “The trustee under Article 8 of the DJZ Trust f/b/o my children” – oldest child’s age
  • “1/3 to each trustee of the separate shares under Article 8…” – Each separate age for each child

 

 

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