Protect your IRA from Your Kids’ Creditors and Their Poor Choices

Don’t Leave Your IRA to Your Kid Outright

IRAs 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:

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

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.

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.