IRA Planning in Light of Robertson v. Deeb

In December of 2009, the Florida Court of Appeals concluded in Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d DCA 2009), that the beneficial interest that a person owns in an inherited IRA may be subject to garnishment. In other words, an IRA that you inherit may be taken by your creditors. This is different from an IRA that you establish yourself, or a retirement plan like a 401(k) or 403(b), which are all protected against creditors.

The result itself did not surprise me much until I read and article by Kristen M. Lynch and Linda Suzzanne Griffin in the April 2010 Florida Bar Journal. Intuitively, it made sense that a creditor can go after an asset that you inherit. Usually, the rule of thumb is that unless an asset is specifically exempted, a creditor can sue to get it.

What made this case unusual, and what I was not aware of, is the fact that there was a specific statute on point, F.S. Section 222.21, which seems to indicate that money payable to the "beneficiary" of an IRA is exempt from all claims of creditors. The Court, however, stated that a beneficiary who inherits an inherited IRA is not entitled to the same protection as a beneficiary who contributes to his or her own IRA.

I do not wish to argue the merits of the Court's decision, but I will point out that as a result of this case, anyone who has a substantial IRA should seriously consider establishing a trust for their loved ones which has "stretch" and asset protection provisions.

For many people, their IRAs are their biggest asset. It is clear, now more than ever, that if you wish to protect your IRA from creditors, you cannot simple name your loved ones as the beneficiaries without risking it being taken. Moreover, you cannot simple name a traditional trust as the beneficiary without incurring large income taxes. You need to do comprehensive IRA planning.

Asset Protect Trusts vs. Family Limited Liability Companies

Occasionally, people who are interested in asset protection ask me what is more appropriate, a trust or some sort of FLC or FLP. Here is my response:

An asset protection trust is more secure than an FLC, but it is also more costly to maintain (high annual fees for an independent trustee) and you give up more control. The more money you have and the more at risk you are for a lawsuit, the more you want to set up a trust. For asset protection trusts to work properly, you must give up almost all decision making power over the assets (to a trusted advisor), and you will become, at best, a discretionary beneficiary of such trust.

A single person FLC does not offer much protection, but certainly some. A two person FLC without an operating agreement offers decent protection from any lawsuit arising out of assets in the FLC, but little protection for misdeeds done outside the FLC. With an operating agreement limiting distributions, you get much more protection and that is why there is more of a setup cost. This structure is good for people who really don’t want to part with their assets and/or think they will need it in the future. These receive more protection over time as the Grantor transfers shares of this down to issue (usually at a discount) because of the lack of marketability and lack of control.

There are many types of Asset Protection Trusts. Inter vivos ones (trusts set up during the Grantor’s life) are invariably more costly than one’s set up on death. Something as simple as a traditional ILIT can make a great Asset Protection Trust, especially if funded with Whole Life Insurance. Self Settled Asset Protection Trusts (where the Grantor is also a beneficiary) are available in a few jurisdictions such as Delaware, Alaska, Nevada and New Hampshire. These are high end domestic asset protection trusts. For even greater protection, we can go offshore.

So, basically, it comes back to what you, the client, is trying to accomplish.

Irrevocable Trusts

There are many different types of irrevocable trusts. The most popular irrevocable trusts include:

1. life insurance trusts;
2. asset protection trusts;
3. charitable trusts;
4. trusts created upon death (such as QTIP trusts and bypass trusts); and
5. special needs trusts.

Generally, an irrevocable trust is designed to prevent its terms from being modified in the future. As a practical matter, what this means is that a person (the Grantor) creates a document (the Irrevocable Trust) outlining how his or her beneficiaries should receive any assets that are placed into the trust.

The Irrevocable Trust document itself has provisions which state that the Grantor may not make changes or modifications to the trust. Unlike a Revocable Trust, the Grantor of an Irrevocable Trust gives up all control once the trust is created. There are times when such trusts can be later modified, whether by court or by consent of all the beneficiaries, but never by the grantor alone.

Frequently people also create an Irrevocable Trust because once assets are transferred to such trust they will receive favorable estate and inheritance tax treatment. Assets in Irrevocable Trusts receive favorable tax treatment because they are excluded from the gross estate of the grantor at the time of the grantor’s death.

Another reason people also create irrevocable trusts is to provide as a means of protecting the assets in the trusts. By giving up control of the assets (in a non fraudulent way), a potential creditor may not sue the Grantor and try to claim against the assets in the trust.

In most states, including New Jersey, a Grantor may not be a beneficiary of an asset protection trust. However, a few states do allow self settled spendthrift trusts.