The Trusteed IRA rules and applications have not been clear. In June 2014 Scotus, fancy way of saying, US Supreme Court, 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 can be created during the IRA owners lifetime (ie. Merrill Lynch model) or after the IRA owner has passed away (ie. Wealth Advisors Trust Company SmartIRA model).
The Trusteed IRA follows the form of an Individual Retirement Account where the custodian 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 the custodial account 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, after the IRA Owner's passing the IRA custodial account splits into separate trusts - 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 potential impact if 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 via her mother's passing inherited an IRA. The question of how this affected Trusteed IRAs had not been raised. They 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 - how far down the chain from the IRA owner does the inherited IRA retains its characteristics.
Anyway, 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 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? So, this case rolled up into the US Supreme to figure this 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 wonkish definition. Section 522 of the Bankruptcy Code covers a wide range of situations. There exists even an association dealing with creditor, and debtor issues for consumers (for those inclined please visit the exciting National Association of Consumer Bankruptcy Attorneys website). Inherited IRAs and eventually Trusteed IRAs fell under their peruse. Taking a step back - Congress (both the House and Senate) involvement in creating laws follow a through discussion and process. Along this line exists the intent of the law. For the Clark vs. Rameker this becomes critical around inherited IRAs, debtors and creditor rights and protections.
Those crazy and lively folks at the National Association of Consumer Bankruptcy Attorneys believed that Congress intent around retirement funds included all types of tax-exempt retirement plans. Now this would include SEP IRAs, 401k Simple, 401ks, Defined Benefit Plans etc. This can just got a bunch 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 latter. 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. Kinda 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 (Founder Fathers bored the latter from England). 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 addition of Internal Code Section of 408 supports the claim of Congress' intent. Rameker, the guy wanting to be paid, did not give up. They argued that the inherited IRA differs from a traditional IRA. They pulled a case law example of Rousey vs. Jacoway from the US Supreme Court. This case, somewhat interesting, helped define that traditional IRAs, including ROTH IRAs, center on people saving for retirement. Remember, traditional and ROTH IRAs have rules for early withdrawals, RMD rules (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 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 protype 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. This benefits exists for spouse and non-spouse trust beneficiaries of the Trusteed IRA.
The Clark vs. Ramker 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.