The Trusteed IRA rules and applications are clear.
In June 2014, the US Supreme Court (SCOTUS) provided a decision on the case Clark v. Rameker. Financial advisors, estate attorneys and IRA owners have not known how to use this easy estate planning tool.
Prior to Clark v. Rameker, many unanswered questions hung frustratingly about. Nobody had considered a simple approach like an advisor-friendly trustee IRA which we call the SmartIRA.
The US Supreme Court via it's decision around Clark v. Rameker now lays out the process for all advisors and clients. The Trusteed IRA can be a natural and easy solution.
Trusteed IRA - How It Works
The Trusteed IRA, at the IRA owner's passing, allows a trust to be treated as an inherited IRA. From this simple statement stems many, many questions.
Typically, an IRA account falls under a custodial account custodied at the normal custodians (e.g. TD Ameritrade Institutional, Schwab Institutional, NFS, Pershing Advisor Services etc.).
The Trusteed IRA follows the form of an Individual Retirement Account where the custodian of the IRA works as a trust rather than just a normal custodian account. This means IRAs formally should be considered as a trust (see IRC Section 408(a)) and yet at the same fall under the definition of a trust account (see IRC Section 408(h)).
This means the Trusteed IRA rules and control follow a trust document and the custodian only holds the IRA assets following the rules of the trustee.
The taxes due on a Trusteed IRA follow the same rules regardless of whether a custodial account is defined as a custodial IRA or a trusteed IRA.
The RMD rules follow the same structure. The critical differences exists whether the IRA Owner wishes to follow Merrill Lynch's or Wealth Advisors Trust Company model.
For the latter, the IRA custodial account splits into separate trusts after the IRA owner's passing — one for each primary beneficiary listed in the IRA custodial account. Each of those trusts RMDs and taxes follow the age of the beneficiary
(Note: See the potential impact of this if the Secure Act becomes law).
Clark v. Rameker
It all started back in 2010 with Brandon Clark and Heidi Heffron-Clark filed voluntary joint Chapter 7.
The daughter, Heidi Heffron-Clark, had inherited an IRA after her mother's passing. The question of how this affected Trusteed IRAs had not been raised. Heffron-Clark claimed an inherited IRA as an exemption under Section 522 of the Bankruptcy Code.
The creditors did not agree with the exemption.
The case ran through the district court, which agreed that inherited IRAs should be exempted from creditor's claim as they do not lose their character when inherited.
Well, that raised another host of questions, especially concerning how far down the chain from the IRA owner does an inherited IRA retains its characteristics.
Eventually, the Seventh Circuit Court of Appeals sided with the creditors that the inherited IRA fell under the claims of creditors.
The main reason for this logic rests on the idea that inherited IRAs should not get the retirement fund exemption because there was no specific clause for the debtor, Brandon and Heidi, that the inherited IRA was set up for their retirement.
So what the heck? How should this concept of a "retirement fund" be defined under the Bankruptcy Code section 522?
That's why this case relied on the US Supreme Court to figure out these boring yet critical definitions. This started the conversation and process of how a Trusteed IRA should be treated under a bankruptcy situation.
Intent of Section 522
This section of the Bankruptcy Code falls under the previous, vague definition.
Section 522 of the Bankruptcy Code covers a wide range of situations. There exists even an association dealing with a creditor and debtor issues for consumers.
Inherited IRAs and eventually Trusteed IRAs fell under their purview. Taking a step back, Congress (both the House and Senate) involvement in creating laws follow a thorough discussion and process. Along this line exists the intent of the law. For Clark vs. Rameker, this becomes critical around inherited IRAs, debtor rights, creditor rights, and protections.
Those crazy and lively folks at the National Association of Consumer Bankruptcy Attorneys believed that Congress's intent around retirement funds included all types of tax-exempt retirement plans. This would include SEP IRAs, 401k Simple, 401ks, Defined Benefit Plans, etc.
That made this can of worms a lot bigger.
The issue started to settle on how (or how not) to protect a spousal-inherited IRA vs. a non-spousal inherited IRA. (This would become a huge factor Trusteed IRA a bit later.)
The concept of the Bankruptcy Code's "fresh-start policy" became a large factor in decided intent and outcome. So, who should get the protection of the "fresh-start policy?" Just spouses of inherited IRAs, or also non-spouses of inherited IRAs?
The plot thickens.
(Kind of exciting.)
Definition of a "Retirement Fund"
The law rests on language. Language rests on interpretation. The parties involved with the law depend on that interpretation through our common law system.
The process started to unwrap the issue of unclear language within statutory text found in the Bankruptcy Code. There exists a whole body of case law around a court using prior intent of a definition, assuming the interpretation does not yield absurd results.
Clark vs. Rameker started to review other legislative goals around protecting tax-favored retirement plans. The Seventh District Court of Appeals had already defined inherited IRAs as retirement accounts.
Clark brought in another intent of Congress — using inherited IRAs for reaching financial planning goals. This statement, when viewed by the IRS's addition of Internal Code Section 408, supports the claim of Congress' intent.
Rameker, the guy wanting to be paid, did not give up. He argued that the inherited IRA differs from a traditional IRA. He pulled a case law example of Rousey vs. Jacoway from the US Supreme Court.
This case, somewhat interestingly, helped define that traditional IRAs, including ROTH IRAs, centered on people saving for retirement.
Remember, traditional and ROTH IRAs have rules for early withdrawals. RMD rules, which will become a huge factor for Trusteed IRAs, and adding to the IRA itself without losing the status.
Great points that leads to the final decision of SCOTUS.
Trusteed IRA Outcome from Clark vs. Rameker
The US Supreme ruled unanimously that inherited IRAs are not retirement funds with the definition of the Bankruptcy Code Section 522(b)(3)(C).
This means inherited IRAs do not provide creditor protection.
The question remains: What happens under a non-spouse inherited IRA owned by a trust? If naming a qualified trust as the beneficiary of an IRA provides the protection, the beneficiary of the trust receives creditor protection under trust law.
(Lots of state and federal case law exists around that fact).
So how does a qualified trust (ie. insert Trustee IRA) get asset protection for non-spouses and still qualify for the benefits of an inherited IRA?
The IRS provides a process where a trust company, like Wealth Advisors Trust Company, can apply to the IRS with their prototype trust document for a Trusteed IRA approval.
Merrill Lynch, Vanguard, Key Bank, USAA, Exeter Trust Company and yes, Wealth Advisors Trust Company applied and received IRS approval. The IRS stated that their Trusteed IRA prototype trust document will be treated as trust with the benefits of an inherited IRA.
These benefits exist for spouse and non-spouse trust beneficiaries of the Trusteed IRA.
The Clark vs. Rameker case provided clear guidance on creditor protection definitions around inherited IRAs. This case also provided the clear guidance on how Trusteed IRAs provide creditor protection for spouses and non-spouses of inherited IRAs.
To learn more about Trusteed IRAs and how they help secure your family's future, take a look at our Trusteed IRA timeline.