Exempt Status of Retirement Plan Distributions

Oct 12, 2021 | General Estate Planning, IRS / Tax Guidance, Podcasts, T&E Administration

“Exempt Status of Retirement Plan Assets,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Susan Snyder, ACTEC Fellow from Chicago. The extent to which assets in retirement plans or distributable or distributed from retirement plans remain exempt from the claims of creditors is the topic of today’s podcast. To learn more we are joined today by ACTEC Florida Fellows Barry Nelson of Aventura, Al Stashis of Naples and Jerry Wolf of Boca Raton. Welcome gentlemen.

Asset Protections for Inherited Retirement Plan Assets

Thank you. As a result of the SECURE Act passed in December of 2019, beneficiaries of retirement plan assets who are not spouses, disabled, minors, and certain other limited classes of beneficiaries can no longer take inherited retirement plan distributions over their actuary lifetime, which used to be called stretch payments. Generally, the maximum duration of payments is 10 years although withdrawals do not have to be made annually as long as the entire plan is withdrawn before the end of the 10th year. And this podcast is focused on the asset protection issues for inherited retirement plan assets. And we also discuss some issues as to distributions from retirement plans during lifetime.

It discusses the asset protection consequences of the accelerated 10-year payout. Our goal is to see if there is any planning to consider for retirement plan distributions to preserve asset protection as to such proceeds once received. We will also describe how different states protect inherited retirement assets differently. And even those that protect inherited IRAs or other inherited retirement accounts while assets remain in the retirement account, once distributed, such assets may no longer be protected.

Multiple Pathways to Asset Protection

For example, if a beneficiary receives a required minimum distribution from an IRA and applicable state law exempts inherited retirement plans from creditors of the beneficiary, can that beneficiary deposit the funds they received into a segregated account and maintain that asset protection? Another issue is whether retirement plan owners should consider designating a trust as the beneficiary for asset protection to protect the retirement assets in the hands of the intended beneficiary. Trust planning is particularly beneficial for states that do not protect inherited IRAs from creditor’s claims of the beneficiary.

The retirement account owner needs to consider asset protection and the SECURE Act to consider if trust beneficiaries are better or safer than an outright distribution. At this year’s Heckerling Institute meeting, Professor Chris Hoyt suggested making a charitable remainder trust as a beneficiary to defer income taxes otherwise incurred by the end of the 10-year maximum term. Based upon state law, a charitable remainder trust may be a good vehicle to pay income tax and asset protection.

The question is whether, under applicable state law, a third party created spendthrift trust, such as testamentary charitable remainder trust that distributes an annual annuity amount to a beneficiary is subject to creditors claims when funds are distributed, and whether such funds can be segregated into an account and retain protection from creditors. ACTEC lawyers are knowledgeable as to the applicable state laws for inherited IRAs. If a state law does not protect inherited retirement assets, then the 2014 US Supreme court case Clark v. Rameker held that inherited IRAs are not entitled to the federal bankruptcy exemption for retirement plan assets.

The Question of Retiree State Laws

As a result, each state law must be considered first, to determine if an inherited IRA or other retirement account is exempt from creditors claims for the beneficiary, or an IRA or other plans. If states, such as Florida, specifically exempt inherited retirement plan assets from the beneficiary’s creditors, then the next question is whether distributions from the retirement account to the beneficiary, if segregated into an account and traceable to the retirement plan are protected once withdrawn.

The issue is more difficult than the SECURE Act because most non-spousal adult beneficiaries who were not disabled must take the inherited retirement assets out no later than 10 years after the death of the person who saved the retirement plan assets. Cases have addressed whether IRA distribution was required distribution or a voluntary withdrawal, and they’ve considered that as a factor. But that distinction is even more uncertain under the SECURE Act, since the mandatory required distribution at the end of the 10 years need not be taken in increments, but all could be taken out before the end of the 10th year. About half of the states have some asset protection exemption for inherited IRAs.

The Question of Beneficiaries State Laws

If you live in one of those states, you should consider whether your beneficiaries also live in that state where the retirement plans paid to inherited beneficiaries of a deceased retirement plan holder are protected. Under Florida law, if a decedent with retirement plan assets leaves the retirement plan assets for Florida residents, then the retirement plan accounts, such as an inherited IRA, is protected from the beneficiary’s creditors.

But if the beneficiary lives in another state that does not protect inherited IRAs or retirement assets, then the retirement assets are not protected under Clark v. Rameker. With those states, paying retirement assets into a qualifying trust may be a better option, and possibly a charitable remainder trust as suggested by Professor Hoyt. Care is required in drafting the trust because certain trusts are not qualified beneficiaries, and the 10-year rule would not be available to delay the required minimum distributions.

Al Stashis is now going to summarize a number of Florida cases that consider whether distributions received from an inherited IRA, stay protected if segregated and then Jerry Wolf will provide a sample of laws that can be enacted to clearly protect retirement plan distributions from the beneficiary of an inherited IRA.  Al.

Protections Afforded by Florida Laws

Thanks very much, Barry. Just as Barry said, by way of background, Florida like a number of other US states opts out of the federal bankruptcy exemptions. And that means that our state statute governs rather than federal law in determining what assets are protected from creditor claims. And generally speaking, our Florida statutes offer very broad protection for a wide variety of assets, including retirement plans. And, as Barry mentioned, in Florida, retirement plans are exempt not only in the hands of the initial account owner but also in the hands of the beneficiary.

So, dad who lives in Miami and has his IRA, that IRA is exempt during dad’s lifetime. If he leaves the IRA to his son who lives in Jacksonville, also a Florida resident, that inherited IRA is exempt as to the son’s creditors. And that sounds simple enough, but even with these broad exemptions, questions can arise as to the actual scope and breadth of the statutory exemptions.

And that’s what we see in our case law. And as Barry pointed out, it’s particularly important now under the SECURE Act where many beneficiaries do not have the ability to maintain the assets within their IRA account. There’s a forced distribution over the 10-year period. And that 10-year accelerated distribution creates not only an inability to defer distributions for income tax purposes, but also raises questions about the asset protection associated with those assets once it’s distributed. And candidly the Florida cases concerning exempt status after distribution from a retirement account are a little bit of a jumble, and that’s the legal term.

Tracing, Voluntary and Mandatory Distributions

My reading of the relevant cases is that they can be divided into two categories. We have some older cases from the early 2000s, cases like Hickox and Ladd. And generally, those cases instruct that tracing is permitted.

As long as we can trace the assets back to the retirement account, the funds will continue to be treated as exempt. More recent cases in Florida, such as Maxwell, Jones, and Universal Physicians tend to apply a much less debtor friendly reading of the Florida exemption statute. And generally, those cases hold that once the assets are distributed from the retirement account and, for example, put into a checking account or a savings account, even if they’re traceable, those assets are no longer treated as exempt. And the courts look to a number of factors, one of which is whether the distribution was voluntary or mandatory in making this determination.

Uncertainties of the Secure Act

Another is whether it’s put into a segregated account or some other form of exempt account or other investment vehicle. But the question about whether the distribution is voluntary or mandatory becomes very significant under the SECURE Act. And that is because under the 10-year rule, there is no required minimum distribution until the last day of the 10th year. But many beneficiaries will want to be able to pay out their accounts sooner and in staged withdrawals for income tax planning purposes so as not to create a bunching of taxable income in the final year. Given the uncertainty that we have in our Florida case law, we recognize the importance of greater clarity in this area of our state law.

For this reason, we’ve recently begun a project within the Florida bar to study whether we need to update our state exemption statute in order to address the exempt status of assets distributed from retirement plans, provided they’re traceable to the retirement account. And Jerry Wolf will discuss that project now.

Florida Bar Study of State Exemption Statute

So, under Florida law, section 222.11 authorizes wage accounts, which exempt wages from garnishment. And the statute basically says that earnings that are exempt and credited were deposited in any financial institution are exempt from attachment of garnishment after the earnings are received by the financial institution if the funds can be traced and properly identified as earnings. With the enactment of the SECURE Act, any planned participants or beneficiaries will be receiving large amounts of deferred compensation payments over a 10-year period. Where in some cases, total deferral for 10 years meant a huge lump sum payment.

Prior to the SECURE Act all deferred compensation funds were able to be retained and paid out over a beneficiaries’ or payees’ lifetime. Now that it has to be distributed out sooner, we want to be able to make sure that those funds are protected as intended by the Florida statute. And so, therefore, we have drafted language, a new statute which is substantially identical to the wage account statute. And is intended to provide that segregated accounts can be set up to receive mandatory distributions from the exemplary retirement account, such as required minimum distributions, as well as voluntary distributions from an exempt retirement account such as any amounts in excess of the RMD or amounts withdrawn from an inherited IRA within the first nine years after the death of the original account owner. Whether or not the statute will be approved by the legislature is – we don’t know right now, but it seems to be consistent with the intent of the Florida legislature and protecting retirement plans and IRAs from the claims of creditors. And this is a lead which we intend to follow in Florida.

Jerry, Al and Barry, thank you. Thank you all for educating us on retirement plans and creditors’ claims.

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