Leave My IRA Out of It

"No way," says a Florida appeals court, ruling that a creditor can reach an inherited individual retirement account

In the current economic climate and with the ever-increasing popularity of individual retirement accounts, asset protection for IRAs is a timely topic. A recent article in the Florida Bar Journal by Kristen M. Lynch and Linda Suzanne Griffin1 highlights a 2009 Florida appeals court case2 of first impression dealing with creditor protection for inherited IRAs. As Lynch and Griffin note, the court’s holding that the debtor’s inherited IRA wasn’t protected from creditor claims under Florida law3 may substantially impact certain beneficiaries of IRAs and other tax-qualified plans.

The case involved Richard Robertson, who was the beneficiary of his father’s $75,000 IRA. When Richard's father died, the IRA custodian gave Richard two options regarding the IRA. The first was to transfer the IRA to an inherited IRA, requiring Richard to take minimum distributions based on his life expectancy and allowing him to withdraw additional amounts without penalty. The second was to keep the IRA in his father’s account and take distributions over five years. Richard chose to transfer the IRA to an inherited IRA. Subsequently, a $188,000 judgment was entered against Richard and the creditor served a writ of garnishment on the custodian of the inherited IRA. Richard filed a claim of exemption, arguing that the inherited IRA was exempt from garnishment under Florida Statutes Section 222.21(2)(a). This section provides that “money or other assets payable to an owner, a participant, or a beneficiary from, or any interest of any owner, participant, or beneficiary in, a fund or account is exempt from all claims of creditors of the owner, beneficiary, or participant if the fund or account” is maintained as an IRA.

Affirming the lower court, the appeals court concluded that Section 222.21(2)(a) doesn’t apply to inherited IRAs because “the plain language of that section references only the original ‘fund or account’ and the tax consequences of inherited IRAs render them completely separate funds or accounts.” According to the court, an inherited IRA is a separate account created when the original account passes to a beneficiary upon the participant’s death. When an IRA becomes an inherited IRA, the account’s tax-exempt status changes, since the beneficiary is required to take distributions and may not roll over the inherited IRA. In contrast, the original IRA owner isn’t required to take distributions (and in fact is penalized for early withdrawal of the funds) and may roll over the IRA without penalty. As Lynch and Griffin point out in their article, the court failed to note that generally the original owner must take minimum distributions beginning at age 70½.

Courts haven’t uniformly treated the issue of asset protection for inherited IRAs. In support of its decision in Robertson, the Florida appeals court cites various federal bankruptcy cases (from California, Illinois, Oklahoma and Wisconsin), holding that inherited IRAs aren’t exempt from creditor claims. In addition, a Texas bankruptcy court recently held that the debtor’s inherited IRA wasn’t exempt from her bankruptcy estate.4 Lynch and Griffin, who contend that Florida law clearly exempts inherited IRAs from creditor claims, discuss a 2010 Minnesota bankruptcy case5 that found that inherited IRAs qualify for exemption from creditor claims under federal bankruptcy law.6

For attorneys practicing in a jurisdiction that doesn’t exempt inherited IRAs from creditor claims, Lynch and Griffin note there are ways to protect IRA assets from claims by a beneficiary’s creditors. For example, instead of naming an individual as direct beneficiary of IRA assets, the owner could create a spendthrift trust for the individual and name that trust as beneficiary of the IRA. Such a trust can be structured to allow use of the beneficiary’s (presumably longer) life expectancy to calculate the required minimum distributions from the IRA. Additionally, the Robertson court seems to distinguish between leaving the IRA in the decedent’s name and taking distributions out over five years, and transferring the IRA into a new inherited IRA, although the court doesn’t directly comment on whether leaving the IRA in the decedent’s name would provide better creditor protection. With IRA assets becoming an increasingly significant portion of many clients’ estates, in situations in which creditor protection for a client’s beneficiaries is a concern, estate planners should be aware of the potential asset protection issues presented by inherited IRAs.

Endnotes

1. The Robertson Case: A Beneficiary by Any Other Name Is Still a Beneficiary,” Florida Bar Journal, April 2010, at p. 34.

2. Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d Aug. 14, 2009).

3. Florida Statutes Section 222.21(2)(a).

4. In re Chilton, 105 A.F.T.R.2d 2010-1271 (Bankr. E.D. Tex. March 5, 2010).

5. In re Nessa, 105 A.F.T.R.2d 2010-609 (Bankr. D. Minn. Jan. 11, 2010), ), aff’d by In re Nessa, 426 B.R. 312 (B.A.P. 8th Cir. April 9, 2010).

6. 11 U.S.C. Section 522(d)(12).

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