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In New York, IRAs Are Losing Their Luster
In New York, IRAs Are Losing Their Luster
By: Stewart M. McGough, Esq.
In terms of dollar value, individual retirement accounts (IRAs) constitute one of the greatest and most pervasive wealth accumulation vehicles in the country, holding trillions of dollars for millions of Americans. No wonder. They enjoy tax-deferred build-up during one’s working years and continued freedom from income taxes even in retirement. They are easily passed on to surviving spouses and family members without entanglement in the owner’s estate. The required minimum distribution (RMD) rules have allowed accounts to grow over decades for the benefit of surviving spouses and second and third generations. Finally, state laws have protected these accounts from creditors of the owners, spouses and beneficiaries both inside and outside of bankruptcy.
Naming a spouse and/or children or grandchildren as a beneficiary oftentimes resulted in complete payout of the account not occurring for 40 years of more. The compounding effect within a tax-deferred account has resulted in enormous accumulations over that time. Add to that the creditor protection afforded by state law, and you have in an IRA a super-loaded trust account that is controlled not by a trustee but by the named beneficiary, a perfect scenario for many families.
However, two recent changes have greatly reduced the IRA’s value as an asset protection and wealth-developing device.
First, Congressional legislation in late 2019 put an end to the multiple-decade IRA payout strategy for second and third generations. While RMDs to the IRA owner and spouse are still based on their life expectancies, once the account becomes payable to a non-spouse beneficiary (with limited exceptions), the account must be fully paid out by the 10th year thereafter. No distributions need to be made before the 10-year period expires, but by the end of that year, full distribution must be made.
Second, a 2019 federal district court ruling from the Northern District of New York (Todd v. Endurance American Insurance Company, 596 B.R. 79) has thrown a curve at traditional IRA planning. In that ruling, the court held that New York’s creditor protection statute for retirement accounts such as IRAs (NY CPLR §5205(c)(2)) does not exempt an IRA from the claims of creditors in a bankruptcy estate of a non-spouse beneficiary who inherited the IRA, nor is the IRA excluded from the bankruptcy estate. The Court listed various characteristics of an inherited IRA (including that the funds can be drawn without penalty at any time, and that no additional funds can be added to the account by the beneficiary) which caused it to view an inherited IRA not as a retirement account for the beneficiary, but merely an inherited asset that, like most other inherited assets, should be available to the beneficiary’s creditors.
So, for New York residents, in the course of just one year, two of the major advantages of an IRA (long-term wealth accumulation and permanent creditor protection) have been greatly diluted.
Nevertheless, careful planning may restore those benefits to a very large degree. For example, instead of naming children and grandchildren as outright beneficiaries, an IRA owner can achieve much of the desired wealth generation by naming a charitable remainder trust (CRT) as the IRA beneficiary. The estate tax charitable deduction that one receives from the funding of a CRT is secondary, if not merely an afterthought. Rather, by naming a CRT as beneficiary, the children and grandchildren can receive an income interest that can stretch for decades.
Moreover, naming a CRT (indeed, any irrevocable trust that contains valid spendthrift provisions) as beneficiary returns the IRA’s creditor protection that was taken away under the Todd case.
The lesson here is to review your IRA beneficiary designations with your advisors and make appropriate changes if the recent changes in the law, as discussed above, now interfere with your objectives.
We’d be happy to review with you your objectives in your estate plan, including the important considerations that IRAs deserve.
