It depends on where you live, or more precisely where your beneficiaries live. In the Fifth Circuit and Eighth Circuit your inherited IRA is protected, but in April this year the Seventh Circuit held that Wisconsin resident Heidi Heffron-Clark’s inherited IRA worth $300,000 was available to her creditors. This was a devastating result for her, and definitely not what her mother envisioned when leaving her lifetime savings to her daughter. What about here in California? The Ninth Circuit has yet to take up the question, and it is anyone’s guess what they will hold should the question come up.
The good news is this: if you are planning on leaving your IRA to your children, or other beneficiaries, there are ways of providing creditor protection with some advanced estate planning.
Ordinarily, you can just name the beneficiary directly. In some cases however, naming a beneficiary directly could be a recipe for disaster. For example you could be leaving a well-funded IRA to a minor who will withdraw every penny as soon as they are able ignoring all negative tax consequences. You could be leaving your IRA to someone is receiving public benefits, immediately disqualifying them from the benefits they are relying upon. A surviving spouse may remarry potentially resulting in none of the benefits reaching your children.
What alternatives are there? One alternative is to name a “see through trust” as the beneficiary. A qualified “see through trust” will allow the beneficiary to “stretch” the IRA distributions out over his or her lifetime, thereby avoiding the tax hit of a forced early withdrawal, and still provide all the benefits of a trust.
Planning who will receive your IRA involves understanding the multitude of tax consequences and the complex rules regarding inherited IRA’s.
Regardless of whether you choose to use a “see through trust” for your family, you should review your IRA beneficiary designations on a regular basis with your financial planner.