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If you are like many Americans, your retirement plan will include some form of qualified retirement plan such as a 401(k), 403(b), or an IRA.  And if that statement applies to you, a recent ruling issued by the Supreme Court of the United States may have you rethink your current estate plan.

In Clark et ux v. Rameker, Trustee, et al, the Supreme Court ruled that an inherited IRA is not exempt under the Bankruptcy Code, and, therefore, is not a protected asset for debtors filing for bankruptcy.  The debtors in Clark, owners of an inherited IRA, applied for bankruptcy and argued that the exemption for “retirement funds” under Section 522(b)(3)(C) exempted their inherited IRA.  The Supreme Court disagreed holding that inherited IRAs are not an exempt asset because they are not retirement funds – funds intentionally set aside for when the individual stops working.

Now what does this mean for an owner of a qualified account who has children?  It means that the use of a qualified account stretch trust can protect these assets for children who are struggling financially.  The following will explain how, but first a quick overview on how qualified accounts are distributed upon the death of the owner if the children are named beneficiaries of the account.

Typically, a qualified account must be withdrawn within one year or five years after the death of the owner of the account.  This means that your children will have to request a lump sum and pay the taxes in that year, or have the account paid out over five years paying income taxes on the inherited money over that period.  An exception to the one and five year rule is that the Treasury Regulations of the Internal Revenue Code allow the beneficiaries to elect to “stretch out” the inherited IRA over their lifetime.

Also, the Treasury Regulations allow the owner of a qualified account to establish a “stretch trust” that will allow the trust to “stretch” the inherited IRA over the beneficiaries lifetime.  Thus, rather than having the money distributed in one year or five years, the trust can stretch the inherited IRA over the children’s lifetime allowing for a steady stream of supplemental income.

Having provided a general overview of the rules of qualified accounts, the importance of the Supreme Court decision in Clark  can now be highlighted.  If you have a traditional estate plan that lacks a “stretch trust” and your children receive the inherited IRA over one year, five years, or over their lifetime, these accounts will never be exempt under the Bankruptcy Code—your children will have to use this asset to pay creditors.  However, if you establish a “stretch trust,” your children can file for bankruptcy and the account will be protected.  Since your children do not own the account – the trust will be the owner – your children can apply for bankruptcy if they find themselves in troubled financial waters and their inheritance will remain protected.  Rather than pay creditors, your children will continue to receive the steady stream of income that can help them rebuild on surer ground.

Therefore, if you have a qualified account and have children that may receive this account as part of their inheritance, it is in your best interest to seek the advice of a qualified estate planner to see if a qualified account stretch trust can help preserve these assets for your children.    If you or your family need assistance with estate planning, please contact the trusted attorneys from Browning & Meyer Co., LPA today.