How to Maximize Your IRA for Future Generations and Protect It from Creditors
Who should read this article? Anyone who has a large part of their wealth in an IRA or Retirement Plan. If you’re like many people with an IRA account, you may consider using it as part of you estate. In that case, you’ll want to maximize your IRA for future generations.
But My IRA is for My Retirement. Why Should I Care About the Next Generation?
Because for many of us, the IRA or Retirement account makes up a large part of our estate. And if the IRA is a large part of our estate, shouldn’t we make sure we get the most out of it? In this article we seek to provide some insight for non-lawyers into the issues of IRA estate planning.
Maximizing the IRA Stretch
The way to get the most out of an IRA, is by maximizing the “stretch”. Simply put the stretch is how long the IRA money can grow tax deferred. As our illustration shows, growing your money, with the power of compounding, in a tax deferred account is quite powerful. It can be an enormous help to our loved ones to have that benefit when they might need it most; after we’re gone.
IRAs and Retirment Plan benefits account for 2/3 of all household financial assets (2007 Investment Company Institute Study).
That’s what we mean by maximizing the stretch: keeping the money in a tax deferred environment for as long as possible. But there’s a catch. The IRS doesn’t want you to keep the money growing tax-deferred. So they make the rules tricky. But even though it is tricky, it can be done. That’s why you should make an estate plan: take advantage of the rules to keep that money growing as long as it can.
RMDs The Required Minimum Distribution
IRA minimum distributions or required minimum distribution rules are meant to cause that IRA money to be taken out of the IRA account as soon as possible. In that case, how can you maximize your IRA for future generations? What if there were a way to keep it in there and growing longer? There is. But staying tax deferred after death of the original IRA account holder or plan participant is tricky.
Why Retirement Planning With Trusts Is Important
Qualified retirement benefits, IRAs and life insurance proceeds = 75-80% of intangible wealth of most middle-class Americans
L. Mezzullo, An Estate Planner’s Guide to Qualified Retirement Plan Benefits (ABA Publications, 4th ed. 2007)
Why should we care about IRA estate planning?
IRA account planning is important because Americans have a significant portion of their estates invested in IRA accounts.
According to the Employee Benefit Research Institute, “The average IRA individual balance (all accounts from the same person combined) was $119,804”
Source: Employee Benefit Research Institute
Although $120,000 doesn’t seem like too much, remember this is an average. We routinely see in our practice IRA accounts in the half million dollar to million and a half dollar range. But if your IRA is worth $120,000 or around the average, and it is fifty percent of your estate, shouldn’t you make sure its properly planned for? So it makes a lot of sense to plan how your IRA will play out during your life, and after your gone. However, the law makes retirement benefits subject to estate and income taxes at death.
What are the perceived benefits of IRAs?
Besides avoiding Probate after death, a traditional IRA grows tax free. Also, there are creditor protections for IRA accounts. These accounts were established by the government to encourage people to save money for their retirement. Because of that, using that money to benefit the next generation can be tricky. Some of our clients ask if there is a way to use part of
the IRA for their spouse, but preserve a portion for their kids or grandkids. The answer is yes. We’ll explain in this article some of the pitfalls of IRA estate planning further on. But first I want to show why IRA estate planning is worth doing.
Let me introduce you to “the stretch”. What is the stretch? That is the game we estate planning attorney’s play to get the most possible tax free growth from an IRA account during the time it must be depleted. Okay, let me break down what that means with a concrete example.
Let’s imagine you have a traditional IRA worth $425,000. With your pension and social security, you have decided that you don’t need the IRA money. However, if you are aged 70 ½ the government rules say you have to start taking money out. This is called the “Required Minimum Distribution”. The only problem with the RMD is that it increases your income, and therefore, most likely, increases your income tax. So, if you’ve decided you don’t need the money to support your lifestyle, you have to take it anyway. However, if you are able to take as little as possible, what is left after you’re gone can be used to benefit the next generation.
How is the RMD Calculated?
The required minimum distribution is calculated based on your life expectancy. Basically it means that the government wants you to have taken all the money out by the time statistics say you’re supposed to be dead. What happens if you die, and there is still money in the account? This is where the stretch comes in. If you make a young person your beneficiary, then their life expectancy is longer, and therefore, they can take less money from the IRA every year. If they take less money, that leaves more money to grow tax free. Remember our illustration of a dollar nineteen growing to one million two hundred thousand dollars in an IRA verses a mere forty eight thousand in a regular account. That’s the stretch. But how do you do this? The answer is with a properly drafted trust.
Using IRA Proceeds to Benefit Subsequent Generations
Since IRAs are such a large part of people’s estates, our clients are frequently seeking to benefit their kids and maybe their grandkids with their IRA money. Can they do it? The answer is yes, but only if they plan carefully, and make a trust, and follow the rules. They can use IRA money to benefit subsequent generations. But what if your beneficiary goes bankrupt? What if your child inherits your IRA and gets divorced? What if you’re estate planning for a second marriage situation, and you want your spouse, AND your kids to get a portion of your IRA? Can you do that? Is your IRA safe from creditors then? Yes, these things happen. And it used to be, that the IRA money was protected from creditors, even after it was inherited. However, not any more. Take a look at this US Supreme Court case which made it more difficult to protect your IRA from creditors.
US Supreme Court Chimes In On Creditor Protection for IRA Accounts
Under a recently decided case, Clark v Rameker, the Court decided that an inherited IRA is not protected from creditors. In the Rameker case, the mom left her IRA to her daughter. It was a substantial account, in excess of a million dollars or more. But unfortunately, after the mom died, her daughter went bankrupt. Her IRA was not protected. Creditors could attach that IRA money. So given the Rameker case, the question is, can you get the benefit of the Stretch, and still protect your IRA from your kid’s potential future creditors? Can you protect your IRA from creditors?
Protect An Inherited IRA from Creditors
The answer again, is, yes! But only if you do it the right way. Estate planning is a process. You need to know what you can do. You need to come up with your rules about what should happen. And you need to tell your rules to someone who knows how to comply with the tricky IRS rules. That’s how you protect your IRA account for future generations, and maximize the stretch. tell your rules to someone who knows how to comply with the tricky IRS rules. Once you’ve made up your mind you want to plan, contact estate planning attorneys. contact estate planning attorneys