There are a lot of good reasons to name your trust as beneficiary or your retirement plan, whether a 401(k), 403(b), or IRA. Trusts provide for management of the IRA beneficiaries who are young, disabled, or for other reasons shouldn’t be managing the asset themselves. People in a second marriage or relationship may want their spouse or partner to benefit from the funds, but not be able to deplete them entirely. And trusts provide creditor and protection.
However, the trust may not protect your retirement funds from your own creditors.
Creditor Protection for Retirement Plans
IRAs enjoy substantial creditor protection during your life. If you get sued, your IRA will be subject to claim, but you can protect it by declaring bankruptcy. Under the federal bankruptcy code, the first $1,362,800 of your retirement assets are protected from having to be paid to creditors. Most cases settle, so you can generally get this protection without having to go through the bankruptcy process, but it’s there if necessary.
But Only During Life
However, that protection ends at death. It does not apply to inherited IRAs, those you leave to others or that you have inherited from others. Those are subject to claim. However, your heirs are not liable for your debts. So, if your retirement plans pass directly to your heirs, they will be protected from your debts.
By way of example, let’s assume an individual dies owing $400,000 to various creditors with a total estate of $500,000 divided between a house with a market value of $250,000, savings of $100,000, and retirement plans holding $150,000. If the retirement plans are paid directly to this individuals heirs, they will not be subject to the person’s debts. The rest of the assets will have to go to pay off debts, leaving nothing in the estate for the heirs, but also leaving the creditors short $50,000.
Revocable Trusts Subject to Claim
But what if the IRAs were payable to the individual’s revocable trust? Then they very well may be subject to claim. The Massachusetts Trust Code at M.G.L. 203E, sec. 505, says:
After the death of a settlor, . . . the property of a trust that was revocable at the settlor’s death shall be subject to claims of the settlor’s creditors . . . to the extent the settlor’s probate estate is inadequate to satisfy those claims.
In other words, if there’s not enough funds in the decedent’s probate estate to pay her debts, the creditors can go after her revocable trust.
The Kansas Case
In at least one case in Kansas, which like Massachusetts and 34 other states has adopted the Uniform Trust Code, the court ruled that this right of creditors to go after the decedent’s revocable trust applied to an IRA payable to the trust. There’s no reason to think that a Massachusetts court would not come to a similar conclusion.
So, if your debts exceed your non-retirement plan assets, don’t make your retirement plan payable to your revocable trust. Either make it payable directly to beneficiaries or, if a trust is necessary, to an irrevocable trust. But if your assets far exceed your debts, or possible lawsuit claims against you or your estate, then don’t worry about any of the above.