Transferring IRA Wealth: Top 5 Mistakes to Avoid. Presented to FPA Ventura County by Christine P. Roberts Mullen & Henzell L.L.P.

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1 Transferring IRA Wealth: Top 5 Mistakes to Avoid Presented to FPA Ventura County by Christine P. Roberts Mullen & Henzell L.L.P. August 18, 2017

2 A Simple Reminder. The information provided in this webinar and written materials is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader or attendee. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation.

3 Roadmap for Our Discussion Recap of IRA Beneficiary Basics Top 5 Mistakes to Avoid in Transferring IRA Wealth Creditor Protection Issues for IRAs and Retirement Plans Brief Update on DOL Fiduciary Rule

4 IRA Issues for Another Day.. We have just enough time to cover Top 5 Mistakes and creditor issues. Therefore, please save questions about the following topics for after the presentation (or for a future presentation): Pros and Cons of Roth IRAs versus Traditional IRAs. Splitting pre-tax and after-tax rollover amounts among separate IRAs. The one IRA to IRA rollover rule, and exceptions to it. Charitable IRA Distributions.

5 Recap of IRA Beneficiary Basics

6 IRA Wealth IRAs were introduced in 1974 just as baby boomers entered the job market. At the end of the fourth quarter of 2015, total IRA assets were estimated at $7.3 trillion.* Rollovers in 2013 added $324 billion and industry watchers expect rollover rate to increase as baby boomers retire.** *Investment Company Institute **Cerulli Associates

7 IRAs are Contract Assets IRAs are part of the holder s estate upon death. However the wealth they hold is transferred separate from other estate assets - through a beneficiary designation, as supplemented by the terms of the IRA contract. Designating an estate or trust as an IRA beneficiary re-routes the IRA assets through the estate or trust.

8 What is an IRA? Individual Retirement Account, created when ERISA passed in Generally consists of a custodial account agreement (can be a trust agreement), financial disclosures and a beneficiary designation. Flavors of IRA: traditional & Roth. We are going to focus on traditional IRAs. Inherited IRA is just a traditional or Roth IRA in the hands of a non-spouse beneficiary. Not an IRS-defined term.

9 Spousal IRA IRAs have most estate planning flexibility when left to a surviving spouse. Spouse can make spousal election or spousal rollover and treat the IRA as his or her own account, with a new lifetime over which to measure Minimum Required Distributions (MRDs). Of course, blended families introduce complexity into the IRA beneficiary designation process.

10 Beneficiary vs. Designated Beneficiary With IRAs, not every beneficiary is a Designated Beneficiary. Stretch-out after IRA owner s death only happens when there is a Designated Beneficiary (DB). A DB must either: Be a human being or Be a trust that looks through to human beneficiaries. A DB can either be designated by the IRA owner or defaulted to under the terms of the IRA contract. An estate can never a DB.

11 Top 5 Mistakes to Avoid in Transferring IRA Wealth

12 Mistake No. 1 FAILURE TO MAKE OR UPDATE A BENEFICIARY DESIGNATION

13 Failure to Make/Update a Beneficiary Designation You would be surprised how often this happens. If the IRA owner does not designate or update a beneficiary designation, the survivors fate turns on default beneficiary language in the IRA contract. Failure to update a beneficiary designation e.g., after a divorce - happens even more frequently.

Failure to Make/Update a Beneficiary Designation IRA contracts generally default to a surviving spouse, which can be a good outcome (except for

14 Failure to Make/Update a Beneficiary Designation IRA contracts generally default to a surviving spouse, which can be a good outcome (except for blended families). If no spouse survives, IRA contract may default to the estate: Unless the estate has large debts, this is almost always a bad result.

15 Failure to Make/Update a Beneficiary Designation IRA contracts sometimes contain language that revokes a standing beneficiary designation of a spouse, upon divorce of the IRA owner. This may be required under applicable state law. This cannot undo community property rights but can be an unpleasant surprise for the survivors. In U.S. v. Egelhoff, the U.S. Supreme Court ruled that ERISA prevented operation of the state automatic revocation law. Former spouse took qualified retirement plan account instead of children. State law might have governed had an IRA been at issue.

16 Failure to Use Most Recent Designation Form When making or updating an IRA beneficiary designation, you must use only the latest & greatest designation form approved for use by the custodian. Do not use paper forms from the client s file and records. Instead, go to the custodian s on-line site and download a designation form from its forms section. Check that the date on the form is within 2 to 3 years and double-check by calling custodian s 800 number to confirm the version you have is still acceptable.

17 Mistake No. 2 FAILURE TO READ THE IRA CONTRACT

18 Failure to Read the IRA Contract This mistake is the flip side of the coin, from Mistake No. 1. IRA owners need to be scared straight - the IRA contract governs the fate of what may be their family s largest single accumulation of wealth. Generally they only run pages; financial disclosures, enrollment materials, prospectuses, etc., add to the bulk of the IRA packet. Isolate the beneficiary designation and custodial account or trust agreement and READ them. If questions arise, get an expert s advice.

19 Failure to Read the IRA Contract I recommend you read the entire IRA contract. However, if you need a short-cut on what sections to focus on, here they are: Beneficiary Designation provisions including, most specifically, the default beneficiary language. Effect of divorce on existing spousal beneficiary designation. Choice of law provisions:

20 Failure to Read the IRA Contract Short-cuts, continued: Effect of IRA account going to a minor or incapacitated beneficiary:

21 Failure to Read the IRA Contract Short-cuts, continued: Provisions related to responsibility for calculating and making MRDs: Also review procedures for splitting IRA account upon divorce or legal separation.

22 Mistake No. 3 NAMING A TRUST AS BENEFICIARY WITHOUT UNDERSTANDING POTENTIAL CONSEQUENCES

23 Naming a Trust as a Beneficiary The two most important things to do if there is a desire to name a trust as an IRA beneficiary are: Make sure that estate planning goals cannot be met, simply using the IRA beneficiary designation (i.e. not routing the asset through the trust); and Make sure the designated trust is a see-through trust, to preserve the stretch option.

24 Naming a Trust as a Beneficiary Generally, it is also important that the trust be designed as a conduit trust that requires distribution of the MRD each year. If the trust is an accumulation trust, it greatly complicates the process of identifying trust beneficiaries. Trust may fail the see-through test and destroy the stretch opportunity.

25 Naming a Trust as a Beneficiary Please note that conduit trust design may directly conflict with estate planning goals, such as: Sheltering the IRA assets from the spouse s estate for estate tax purposes; Putting a barrier between the beneficiary and the IRA funds. You need a good estate planning attorney s help.

26 Naming a Trust as a Beneficiary Two options to consider before designating a trust: Use the IRA beneficiary designation to track what the trust would do with the asset. Don t freelance have the estate planning attorney supervise this effort. Use a trusteed IRA an IRA established with a trust agreement rather than a custodial account agreement. IRA holder may be able to pre-designate who will take account on the death of the primary beneficiary. Useful in cases of capacity/spending concerns.

27 Mistake No. 4 NAMING AN ESTATE AS BENEFICIARY WITHOUT UNDERSTANDING POTENTIAL CONSEQUENCES

28 Naming an Estate as a Beneficiary Most often an estate is named as an IRA beneficiary out of simple misunderstanding of what an estate is and how it is taxed. An estate can NEVER be a DB; for IRAs not in pay status the 5-year rule will apply unless a spousal conversion is possible. Generally, designating an estate is only a good idea if the client needs the IRA assets to pay debts postdeath.

29 Naming Estate as a Beneficiary When an estate is the designated IRA beneficiary, there are some alternatives to probating the IRA: Spousal conversion through the estate. This is the ONLY ways to preserve stretch-out. Assigning the IRA to a trust or other beneficiary. This will not change application of the 5-year rule. Re-designating the IRA account as an inherited IRA in the name of the decedent, FBO the trust (or other beneficiary). This will not change application of the 5-year rule. For assignment/re-titling your IRA custodian s cooperation will be needed and it is not universally available.

30 Mistake No. 5 NOT UNDERSTANDING SPOUSAL ELECTION RIGHT IN RELATION TO THE BENEFICIARY DESIGNATION

31 Not Understanding Spousal Election Often, the best IRA beneficiary is a surviving spouse who is younger than the IRA holder. Surviving spouses can make a spousal election, sometimes called a spousal rollover, that gives the IRA a fresh start on MRDs and beneficiary elections. The spousal election jump starts the IRA stretch.

32 Not Understanding Spousal Election A spousal election may still be available where an IRA beneficiary designation names an estate or trust. Under the trust or will, surviving spouse must have, and exercise, the right to demand payment of IRA benefits to him or herself. There is no IRS rule on this point but in multiple PLRs the Service has interpreted Treasury Regulations re: rollovers and MRDs to permit spousal elections through an estate or trust.

33 Not Understanding Spousal Election Generally you will need a letter from a lawyer to the IRA custodian, explaining the legal precedent for permitting spousal election through trust/estate. Drafting lawyer will need to read will/trust to confirm that spouse s right to the IRA funds is unfettered; i.e. Spouse is sole trustee of the trust/executor of estate. Spouse has sole authority under trust/will to pay the IRA proceeds to him or herself.

34 Post-Death MRD Chart for IRAs Beneficiary is: Year of IRA Holder s Death: IRA Holder Died>RBD* IRA Holder Died After RBD Any beneficiary: N/A; no MRD for YOD Beneficiary must take or complete MRD for YOD Later Years: Surviving Spouse: Non-Spouse DB: Non-DB (estate; charity, nonsee-through trust): Spousal election (fresh start) or distribute over spouse s life expectancy/5 years. Distribute over beneficiary s life expectancy (or that of oldest beneficiary of seethrough trust)/5 years. 5-year rule applies. Spousal election or distribute over longer of spouse s life expectancy, or that of deceased IRA holder. Distribute over longer of DB s life expectancy (or that of oldest beneficiary of seethrough trust), or that of deceased IRA holder. Distribute over deceased IRA holder s remaining life expectancy. Source: Choate, Natalie B., Life and Death Planning for Retirement Benefits (11 th Ed. 2010), Section

35 Creditor Protection for IRAs and Retirement Plans

36 Creditor Protection: IRAs and Retirement Plans Retirement Account Bankruptcy Creditor Other Creditors (CA) Traditional/Roth IRA: SEP-IRA or SIMPLE-IRA: Solo 401(k) and other Non-ERISA plans: ERISA Plans: Rollover to IRA from ERISA Plan: Inherited IRA: Exempt up to $1 million* (one limit for all IRA accounts in aggregate). Unlimited exemption. Unlimited exemption. Unlimited exemption. Unlimited exemption. No exemption; state law will govern. See Clark v. Rameker. Exempt only as necessary to provide support in retirement. Same as above. Same as above. Protection from most creditors (IRS excepted). Depends; see McMullen v. Haycock. Exempt only as necessary to provide support in retirement. *$1,283,025 as adjusted for inflation; this limit applies through March 31, 2019.

37 Creditor Protection: IRAs and Retirement Plans Post-Clark, if creditor protection is a concern, leave IRA to a surviving spouse or a see-through trust. The spousal election turns the inherited IRA into a brand-new individual retirement account for purposes of creditor protection. Creditors of the IRA holder generally would not have access to trust assets including the IRA even when it meets see-through requirements.

38 Creditor Protection: IRAs and Retirement Plans The question for business owners with ERISA plan accounts: should I stay or should I go? Must weigh costs/benefits of keeping ERISA Plan in place: Benefit is iron-clad protection against non-irs creditors. Costs include annual administration fees and possibly higher investment fees; periodic plan document amendments, etc.

39 Creditor Protection: IRAs and Retirement Plans Business owners should be aware of the difference between an ERISA plan and a tax-qualified plan that is exempt from ERISA. E.g. Solo 401(k) or solo defined benefit plan; owner + spouse only plan, accounts under SIMPLE-IRA and SEP-IRA plans (exempt from ERISA reporting and trust requirements). Only the ERISA plan has maximum protection from creditors. Must have at least one employee participant other than owner/spouse.

40 Update on the DOL Fiduciary Rule

41 DOL Fiduciary Rule Fiduciary rule went into effect June 9, 2017 but full compliance with Best Interest Contract Exemption (BICE) and other PT exemptions is not required until January 1, DOL has asked for 18-month extension for full BICE/exemption compliance to July 1, 2019; subject to OMB approval but probably will be granted. In the meantime, advice to IRA owners must meet impartial conduct standard (replacing suitability standard): Best interest standard of care; Only reasonable compensation; and No misleading statements.

42 DOL Fiduciary Rule Rollover advice during the transition period: advising whether or not to take a plan distribution and roll to an IRA is fiduciary advice. Advising to roll to a financial institution that pays the advisor compensation is automatically a prohibited transaction. Therefore a PT exemption is needed. Transition BIC : comply with impartial conduct standards and document the reasons why the advice was considered to be in the best interest of the retirement plan advisor.

43 DOL Fiduciary Rule In the case of investment advice to roll over assets from an ERISA plan to an IRA, this documentation must include consideration of the retirement investor s alternatives to a rollover, including leaving the money in his or her current employer s plan, if permitted, and must take into account the fees and expenses associated with both the plan and the IRA; whether the employer pays for some or all of the plan s administrative expenses; and the different levels of services and investments available under each option. Conflict of Interest FAQs, Part I Exemption; Q&A 13 (October 27, 2016)

44 DOL Fiduciary Rule Enforcement of the rule lies with individual investor lawsuits, not the Department of Labor or other government agency. Large investment companies, e.g., Fidelity, Merrill Lynch, have generally moved forward with compliance despite political uncertainty. LPL: brokers cannot recommend re: 401(k) rollovers to IRAs; education-only policy.

45 Questions and Contact Information Questions?? Contact Info: Christine P. Roberts Mullen & Henzell L.L.P. 112 E. Victoria St. Santa Barbara, CA (805)

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