Protecting The Beneficiaries Of Your 401K From Creditors

You may not know that a Judgment Creditor may not attach your 401k in the event you have been sued, a judgment occurs and a creditor seeks to seize your 401k. This may arise when you owe a debt that is overdue and the party who loaned you money or provided services or property for which you have not paid sues you and is successful. The person who sued you and won the suit may then obtain a judgment against you. Another circumstance is when you have been found negligent while driving by the Court and a judgment against you is issued which exceeds the limit of your liability insurance coverage. The person who is successful in getting the judgment is called a “judgment creditor”. That person can do what is called “supplementary proceedings” and have you appear in court. The judgment creditor then asks you about your assets and income with the view to garnish your wages and attach your assets but can’t attach the judgment against your 401k.

However, let’s assume that you name your spouse, children, other relatives or friends, as a beneficiary of your 401k. They do not have the same protection as you do. When you die, the beneficiaries have the right to claim all or part of your 401k. However, in the examples above, the judgment creditor can, after your death, attach the 401k. Often owners of 401ks are unaware of that opportunity of the judgment creditors to which your beneficiaries are exposed.

The ways to deal with potential judgment creditors seizing your beneficiaries’ 401k assets are as follows: (1) to have in place a last will and testament which includes a testamentary trust; or (2) to have an inter vivos trust. Then, upon your death, your beneficiaries will be protected from judgment creditors collecting against your 401k plan and other assets. The trusts will protect your beneficiaries from judgment creditors just as you were protected from them during your lifetime of your 401k.

An additional benefit of the trusts is that you may designate in the trust how often and in what amounts your beneficiaries may receive income and/or principal. (There are exceptions involving minimum required distributions described below). If you don’t have a trust in place, then the administrator of your 401k after your death will provide your beneficiary with options either to receive a lump sum distribution or distributions that permit a serial pay out.

There is one major distinction regarding minimum distributions and that has to do with the United States tax regulations. Understand that the funds in a 401k are not taxed while those funds remain in the 401k. However, when the funds are distributed, they are taxed as ordinary income. Also there are rules involving minimum mandatory sums of annual payouts to beneficiaries. The minimum mandatory annual sums are geared to the beneficiary’s age. If there is more than one beneficiary, then the government uses the oldest beneficiary’s age and distributions must be paid based on life expectancy of the oldest beneficiary.

In addition to your testamentary trust or your inter vivos trust directing your 401k to your intended beneficiary, you can designate who the trustee is and grant the trustee, who has the decision making authority as to who will manage the assets of the 401k, the right make additional distributions to the beneficiary.

When you read this article and you want to do something, you need me as your attorney to prepare the documents to make sure the documents achieve specific objectives.

Fred Antenberg has advised clients in Howard County, Maryland, and surrounding counties of Baltimore City over a period of more than 30 years as to the ways to protect their beneficiaries in a number of types of trusts including gifts and other ways to save on Maryland Estate Taxes and Federal Estate Taxes. Call Fred for a Free Initial Consultation at 410 730 4404.