IRA Update

Quick-Take: Back in 2020 I wrote a missive on how IRAs are protected from judgement creditor claims under Michigan’s exempt property statute. [MCL 600.6023(k)(l).] What was pointed out in that missive was that in 1999 a U.S. Bankruptcy judge in Michigan interpreted that exempt property statute to protect only one IRA, based on how that statute is written (‘an IRA.’) Consequently, if an individual owns more than one IRA, they might want to consolidate those IRAs into a single IRA to assure the full creditor protect that Michigan statute affords the IRA owner. [For bankruptcy protection, what is protected in bankruptcy is not the number of IRAs, but their aggregate value, for which there is a high ceiling, like $1.2 million.]

Roth Conversions: Much of the estate planning literature these days stresses the importance of Roth IRAs for a variety of reasons, including: (i) tax-free earnings; and (ii) no required minimum distribution (RMD) obligation. Thus, the uptick of interest in ‘back-door’ Roth conversions and the conversion of traditional IRAs to Roth IRAs. Even some provisions of the SECURE 2.0 Act seem to encourage more Roth retirement accounts (but that probably more to encourage current tax revenues by making after-tax contributions to Roth accounts.) However, due to the income tax-cost incurred with a Roth conversion, many Roth IRA conversions are spread-out over multiple years. If that is the case, then the IRA owner will have, during that conversion period, two IRAs: (i) their ‘shrinking’ traditional IRA and (ii) their converted ‘growing’ Roth IRA. But that then leads to the individual owning two IRAs at one time, and if the federal bankruptcy judge is correct, only one of the two IRAs will be exempt from judgement creditors.

What’s Next? The Michigan State Bar’s Probate and Estate Planning Council is currently looking at a proposed amendment to Michigan’s exempt property statute to expand the type of exempt assets from creditor claims to include inherited IRAs to go along with the traditional and Roth IRAs which are already listed in the statute. I’ve suggested that if the Probate Council seeks to add inherited IRAs to the Michigan exempt property statute, now would be a good time to also address the apparent limitation in the statute that only one IRA is protected from creditor claims, primarily to address the ‘serial Roth conversion’ situation.

The Point: When discussing with clients the benefit of a Roth conversion, it would be best to also mention to the clients that currently there is some concern that only one IRA is protected from creditor claims if the Roth conversion would take place over several years.