Linkedin web ny inherited retirement assets

Protection of Inherited Retirement Accounts After Clark v. Rameker

Matthew E. Rappaport, Esq., LL.M.

Karol & Sosnik, P.C.

600 Old Country Road, Suite 505

Garden City, New York 11530

(516) 745-0066

[email protected]

Creditor Protection of Retirement Assets Generally

Under both federal and state law, an individual’s retirement accounts are generally protected from outside creditors (i.e., creditors other than an ex-spouse). The federal exemption is found in 11 U.S.C. §522(b)(3)(C). The state exemption is found in § 282 of the Debtor & Creditor Law and § 5205(c)(2) of the Civil Practice Law and Rules. The state exemption incorporates the federal exemption by reference.

The exemptions make retirement accounts functionally impossible for outside creditors to access. New York and federal courts will not allow outside creditors to penetrate such accounts unless, perhaps, in truly extraordinary circumstances.

Creditor Protection of Retirement Assets Generally

The very strong creditor protection features of retirement accounts make them excellent asset protection vehicles. However, until 2014, there was some debate among practitioners regarding whether the same creditor protection would apply to retirement accounts inherited by the original owner’s designated beneficiaries.

The Supreme Court decided Clark v. Rameker in June of 2014 and removed all doubt: retirement accounts inherited by non-spouse beneficiaries are not protected from any creditors at all. The decision confirmed that in order for inherited retirement accounts to be protected from the beneficiaries’ creditors, additional measures must be taken.

Clark v. Rameker, 573 U.S. _____ (2014)

Facts: Ruth Heffron set up a traditional IRA in 2000. She named her daughter, Heidi Heffron-Clark, as the sole beneficiary. Ruth died in 2001. At that time, the total value of the assets in the IRA was approximately $450,000. Heidi chose to take monthly distributions to satisfy her RMD requirement.

In October 2010, the Heffron-Clarks filed for Chapter 7 bankrtupcy. They claimed the IRA, which was still worth $300,000 at that time, was exempt from the bankruptcy estate under 11 U.S.C. § 522(b)(3)(C). Rameker, the bankruptcy trustee, disagreed with the exemption and filed suit.


The Supreme Court’s Holding: Inherited retirement accounts do not fall within the definition of “retirement funds” under 11 U.S.C. §522(b)(3)(C). Congress never meant for inherited accounts to fall within the exemption. Three characteristics separating inherited accounts from other accounts support this claim:

• Beneficiaries may never invest any additional money into an inherited account.

• Withdrawal of the funds is required regardless of the beneficiary’s age or distance from retirement.

• The holder of an inherited account may withdraw the entire balance without any penalty.


The Supreme Court’s Holding (Cont.): Exempting inherited accounts from the bankruptcy estate would be unfair to creditors and would not fulfill the exemption’s purpose of “protecting [only] the debtor’s essential needs.” Exempting inherited accounts would turn a “fresh start” into a “free pass” for the debtor.

Any other conclusion would frustrate Congressional intent, upset the balance of creditors’ interests and debtors’ interests, and run counter to the plain meaning of the statute’s language.

Creditor Protection of Inherited Retirement Accounts After Clark v. Rameker

After the Supreme Court resolved the debate, it is now essential to take additional measures in order to ensure the protection of inherited retirement accounts from creditors.

The prudent way to do so is to name a trust as beneficiary of a retirement account rather than an individual. As long as the trust qualifies as a beneficiary of the account, distributions can be made to the trust instead of the trust beneficiaries individually. The trust may be written with customized asset protection language. For example, the trust may include a spendthrift clause, and the trust may give the trustees wide latitude when deciding whether to make distributions of income or principal to beneficiaries.

Properly Setting Up an Accumulation Trust

In order to avoid adverse income tax consequences, practitioners must take special measures during the drafting and administration process.

First and foremost, the practitioner must qualify the trust as a valid account beneficiary. Otherwise, all of the account’s funds must be distributed to the trust within five years of the original owner’s death. § 401(a)(9)(B)(ii). The trust qualifies as a valid account beneficiary if the following conditions are met:

1. The trust is a valid trust under state law, or would be valid but for the fact that there is no corpus (yet).

2. The trust is irrevocable, either upon formation or by virtue of the account owner’s death (note that this rules out all joint trusts).


3. The beneficiaries of the trust must be identifiable. “Identifiable” means

(a) a named individual, or

(b) a class, provided that the youngest member of the class may be identified.

4. The trustee of the trust provides to the retirement plan administrator, by October 31 of the calendar year following the calendar year of the account owner’s death, either

(a) a list of all trust beneficiaries, including contingent and remainder beneficiaries, that is certified by the trustee to be true and correct; or

(b) a copy of the actual trust document.


The trust will qualify as a beneficiary only if all four requirements are actually met. Treas. Reg. § 1.401(a)(9)-4, A-5(b). When the trust qualifies as a beneficiary, the law “looks through” the trust to its individual beneficiaries in order to determine the time frame for required minimum distributions. Treas. Reg. § 1.401(a)(9)-4, A-5(a).

In addition to specifying the right creditor protection measures, an accumulation trust must also be specially drafted to ensure maximum income tax benefits.


Background: Upon the death of the owner of a retirement account, the general rule is that the entire account must be distributed within five years of the owner’s death. § 401(a)(9)(B)(ii). If the owner has designated a beneficiary, distributions will instead be made over the life of the designated beneficiary. § 401(a)(9)(B)(i). Plans may mandate the use of the five-year rule or allow employees to choose whether the five-year rule or the designated beneficiary rule applies. Treas. Reg. §1.401(a)(9)-3, A-4(b), (c).

These rules raise an important question: if the law will “look through” a qualifying trust to its beneficiaries, and the trust has multiple beneficiaries, then whose life must be used for purposes of the distribution?


The answer: if a qualifying trust has multiple beneficiaries, the life of the beneficiary with the shortest life expectancy will be used as the measuring life. Treas. Reg. § 1.401(a)(9)-5, A-7(a)(1). Even beneficiaries with remote contingent interests will be considered for purposes of determining who has the shortest life expectancy. Treas. Reg. § 1.401(a)(9)-5, A-7(b); see IRS PLR 200228025.

Consider the following example: an IRA’s beneficiary is a qualifying accumulation trust with the owner’s surviving grandchildren listed as the class of beneficiaries. The trust has a “takers of last resort” provision stating that if the class of grandchildren does not survive, the beneficiaries shall instead be the owner’s then surviving issue. Even if the owner has eight grandchildren, and the class is therefore not reasonably expected to ever predecease the owner, the owner’s spouse and children will still be considered beneficiaries for purposes of determining shortest life expectancy.


How do we avoid such an adverse result? The accumulation trust must be divided into separate shares. When the trust is divided into separate shares that are considered entirely separate trusts, each individual beneficiary’s distributions are determined by his or her own life expectancy. Treas. Reg. §1.401(a)(9)-8, A-2(a)(2); see IRS PLR 200537044, IRS PLR 201503024.

The difference between an “accumulation trust” and a “conduit trust” is that an accumulation trust allows for the required minimum distributions (RMDs) to remain in trust, whereas the conduit trust passes through all RMDs to its beneficiaries. The conduit trust has far fewer asset protection benefits, but it may be useful if asset protection is not a major concern and the owner of the retirement account still wants to max out the income tax benefits for multiple non-spouse beneficiaries.


This brings up one final question: how should each recipient trust be set up such that it properly plans for “doomsday” scenarios, but it doesn’t trigger determination of the RMD schedule by reference to a remote contingent beneficiary?The answer: only name one beneficiary for each trust, and provide that the contingent beneficiaries shall only be each beneficiary’s issue. Although not explicitly stated, the original owner’s intestate heirs would inherit by operation of law in default of any such issue. If the typical “doomsday provision” is included in the trust, the remote contingent beneficiaries will be fair game for determining who the oldest beneficiary of the trust may be. Compare IRS PLR 200228025 with IRS PLR 201320021. The distinction may be arbitrary, but the letter rulings show that the distinction makes a difference for the IRS. Id.; see Bruce Steiner, LISI Employee Benefits and Retirement Planning E-Mail Newsletter #625 (Aug. 8, 2013).

Questions and Further Discussion

If you have any questions or would like to discuss this topic further, feel free to contact me.

Matthew E. Rappaport, Esq., LL.M.

Karol & Sosnik, P.C.

600 Old Country Road, Suite 505

Garden City, New York 11530

(516) 745-0066

[email protected]

READ THESE IMPORTANT DISCLAIMERS

This presentation is meant for informational purposes only and does not give rise to an attorney-client relationship between the presenter and any of the attendees, listeners, or subsequent readers of the presentation material. This presentation is intended for general education and is not intended to be legal or tax advice. The concepts discussed herein should not be applied without consulting a qualified professional for individual legal and/or tax advice.

U.S. Treasury Circular 230 Notice: To the extent that there may be deemed any tax advice contained in this presentation, it was not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties that may be imposed under the Internal Revenue Code or by any governmental tax authority or (b) promoting, marketing or recommending to another party any tax-related matter addressed herein.

Linkedin web ny inherited retirement assets

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