Asset Protection Planning Developments and Reminders

As an asset protection planning attorney who practices in Michigan and Ohio, I am well aware that this area of the law is very fluid. Recent cases remind us that the law changes from time to time and that there are frequent exceptions to the general rules.

Inherited IRA’s.

Take for example the Seventh Circuit’s decision in the bankruptcy case In the Matter of Brandon C. Clark and Heidi Heffron-Clark. The issue was whether in a bankruptcy an inherited IRA is entitled to the same creditor protection as the original holder’s IRA.

It is clear under current law that creditors cannot reach a debtor’s interest in his or her IRA (up to $1,095,000 at this time). Likewise, if a married holder of an IRA dies and the decedent’s spouse inherits the IRA (the survivor can keep it separate or roll it over into his/her own IRA) the exemption from creditors remains intact. The more difficult question has been whether an inherited IRA retains the same creditor protection; more precisely, does an IRA beneficiary other than the decedent’s spouse enjoy this benefit. The Eighth and Fifth Circuits have decided that inherited IRA’s are entitled to the same creditor protection as afforded the original IRA holder. The theory generally espoused is that any money representing retirement funds in the decedent’s hands must be treated the same way in the successor’s hands.

Recently, the Seventh Circuit has taken a contrary position. It observed that the tax rules that apply to inherited IRA’s are very different from those applicable to the original IRA holder. For example, (1) the inheritor must begin distributing from the IRA within a year of the decedent’s death and (2) pay out must be completed in as little as five years in some cases. As such, the court noted, it is no longer a retirement vehicle where incentives exist to defer pay out until retirement. The court refused to be persuaded that this account should receive the same special creditor protection afforded the original holder and surviving spouse when it was no longer in any sense a retirement plan.

It is only a matter of time before the conflict among the circuits will be resolved by the Supreme Court. For now, if you are counseling a debtor in a bankruptcy proceeding in the Fifth, Seventh or Eighth Circuits, you have guidance on whether an inherited IRA is exempt. Otherwise, you will need to look to precedent in the specific Bankruptcy Court and to the District Courts to which an appeal will lie for guidance.

Social Security Benefits.

Asset protection lawyers know that social security benefits are exempt from creditor claims…except that is not exactly true. One of the creditors that can reach Social Security benefits is the IRS. In a case challenging the right of the IRS to levy on a taxpayer’s Social Security benefits the Magistrate in a North Carolina District Court analyzed applicable Social Security and tax collection law and concluded that the Internal Revenue Code specifically authorizes tax levies and does not exempt Social Security retirement benefits from such tax levies. While the Social Security law is silent on the issue the tax law is quite clear. A word to my asset protection planning bretheren–don’t overlook this exception in advising clients on the safety of their Social Security benefits.