Many of you may already know that the Florida statutes protect IRA accounts from garnishment by creditors. The Second District Court of Appeal in Florida has recently ruled that creditor protection does not apply to an inherited IRA.
In Robertson v. Deeb the court found that despite a state law protecting retirement accounts, inherited IRAs are not exempt from seizure by creditors. The court reasoned that an IRA can be transformed into something different when the original account owner dies and leaves it to an heir who converts the assets into his own inherited IRA.
While the decision turned on Florida law, the court drew much of its reasoning from federal tax and bankruptcy law, even though the defendant was not in bankruptcy.
In this case, Richard Robertson borrowed money from Kevin Deeb and signed a promissory note. According to the opinion, Deeb sued Robertson for default and got a judgment exceeding $180,000. Deeb discovered that Robertson had $75,000 in cash and securities inherited from his father in a bank custodial account entitled, “Richard A. Robertson, Beneficiary, Harold Robertson Decedent Custodial IRA.”
Florida law provides that “money or other assets payable to an owner, a participant or beneficiary” are exempt from “all claims of creditors” if held in a “fund or account” maintained as an IRA exempt from taxation. The 2d DCA held that the protection under Florida law applied only to the original IRA account, and not to an inherited account, stating that “the tax consequences of inherited IRAs render them completely separate funds or accounts.”
It seems counter to the judgment that monies in both original IRA accounts and inherited IRA accounts are not taxed until distributed. But the court noted that whereas original IRA owners can be penalized 10% for certain withdrawals before they turn 59½, federal tax law allows heirs, regardless of age, to take immediate distributions from inherited IRAs without paying the 10% penalty.
The Florida opinion suggested – but did not state expressly – that Robertson may have won had he chosen an option offered to him by RBC to retain the assets in the original IRA account. Had he done that, however, he would have lost years of income tax deferral because the assets would have had to be withdrawn – and taxes paid on the withdrawals at ordinary income tax rates – within five years.
Robertson instead chose the inherited IRA option, which allows an heir to stretch out withdrawals over his expected lifetime. The court reasoned that moving the money to an inherited IRA account resulted in the creation of a new unprotected account from creditors.
The court cited various bankruptcy court rulings hinging on public policy concerns that IRA accounts are exempt as they are retirement savings but those same public policies did not extend to the account holder’s heirs and beneficiaries. A 2005 federal law generally limits IRA protection in bankruptcy cases to $1 million.
I believe that there remains a means to provide some level of protection to inherited IRAs, and that is through a sub-trust that would be named as a beneficiary to an IRA yet would qualify under the “identifiable beneficiary” rules. Although this is too lengthy to discuss in this column, information is available on my firm web site http://www.sbshlaw.com/ – click on “Estate & Trust Planning” in the left hand menu and then click on “IRA Frequently Asked Questions.”
©2009 Craig R. Hersch