Inheriting an IRA Can Present Unexpected Problems for Physicians

One of the nice features of an IRA is the ability to leave it to heirs.  This is especially beneficial for inheriting children, who then have the ability to “stretch” out the IRA distributions over their much longer lifetime.  These distributions are taxable in the inheritor's tax bracket if the IRA was pretax, while an inherited Roth IRA distributes funds tax free.

In Washington, the very concept of inheriting and stretching out an IRA is under attack.  There are repeated efforts to force total distribution of an IRA within five years of death (unless is the recipient of the IRA is a surviving spouse).

However, even if the law does not change, many physician families should be concerned about inheriting an IRA from elderly parents.  This is due to the fact that the asset protection afforded to one’s own IRA or rollover IRA (from a retirement plan) may be lost with an inherited IRA.

In a recent case  the Supreme Court ruled that an inherited IRA is not afforded the protection of non-inherited IRAs in bankruptcy. We need to be concerned that state courts will also find that there is no intrinsic asset protection for assets in an inherited IRA. It is conceivable that these funds will be regarded as no different than solely owned assets (i.e., no protection from creditors).

Note that a few states have specifically ruled or provided asset protection for inherited IRAs (such as Florida), although many have not.

If your state does not specifically provide asset protection for inherited IRAs, you should discuss your options with a skilled estate planning attorney.

One fix for this issue is to discuss having your parents put a trust as the beneficiary of their IRA.  This trust must have specific language to allow you to stretch out distributions over your lifetime, so don’t use an existing trust that has not been reviewed if this is desired.  If you are subject to a lawsuit, the bulk of the IRA would be protected by spendthrift provisions with such a trust, yet your future required distributions may be exposed.

Another alternative is to inherit the IRA in a trust that is designed for control of distributions and/or asset protection.  Such a trust allows the trustee to hold off making distributions if a creditor is on the horizon.  The cost of doing so is the loss of the ability to stretch out distributions over your lifetime.  In this case, if the parent died before starting required distributions, you will need to take out taxable distributions of the entire account within five years.  If the parent had already starting taking required distributions, you are permitted to take distributions over the parent’s life expectancy (per IRS table).

Asset protection is an increasing concern of many of us.  Not understanding that a large IRA inherited from a parent is vulnerable could be a tragic error.