Your Business and Your Life

This week we’re going to discuss an important and overlooked issue in most financial and retirement plans. It affects even your estate plan.

Few IRA owners give much thought to their custodians. Those that do, focus on investment options and fees. Yet, there is a wide range of other issues you should consider, because the custodian can make or break your financial plan. All custodians are not equal. Take a few minutes to learn about your custodian and its policies.

Your IRA must be held by a custodian or trustee. Most financial services firms serve as custodians: brokers, banks, insurance companies, mutual fund companies, credit unions, independent custodians, and trust companies.

Remarkably, considering the amount of assets in IRAs, there is little regulatory monitoring of IRA custodians. The IRS reviews nonbank custodians, but most IRA custodians are structured so their IRA custodial operations technically are banks. States generally supervise the banks, but bank examiners don’t put a priority on IRA custodianship issues.

Most of the major Ponzi schemes that came to light recently included IRA investors among their victims. These frauds were perpetrated on investors who used true self-directed IRA accounts to invest in non-traditional assets. Victims of three of the major frauds (including Bernard Madoff) held their accounts at Fiserv, which was recommended by the schemers.

This is lesson one about custodians. Few of them consider it part of their job to offer you any protection. The custodians generally do not view it as their duty to obtain and hold paperwork proving the existence of assets. As a general rule, they will accept the word or minimal documentation of the investment firm you tell them to contact.

You are on your own when it comes to IRA investments. Most custodians simply will take orders from you. They won’t review your choices or look beyond any numbers provided by the investment firms you choose to invest with.

IRA custodians also are not there to give you tax advice. The larger custodians have staffs of IRA specialists who are available to review the rules with you and work with your attorney or accountant. But custodians don’t review most of your transactions for compliance with the tax law. They also make clear they are not serving as your tax advisor, making recommendations, or taking responsibility for results.

The tax law is fraught with landmines for IRA owners. You might select investments that are prohibited by the tax law, such as life insurance. Or you might select an investment that triggers penalties or adverse tax consequences, such as a collectible. Some custodians will flag such transactions and warn you before completing the transactions, but most won’t. But they all will issue required reports to the IRS.

Custodians also are not likely to alert you to the adverse tax consequences or difficulties of some investments. For example, buying master limited partnerships, debt-financed property, or collectibles with your IRA can trigger taxes.

Few custodians alert IRA owners that withdrawals before age 59½ will trigger a 10% penalty when the distribution doesn’t qualify for an exception. Those over age 70½ often aren’t given guidance from custodians about their obligation to take required minimum distributions.

Even the good custodians are not perfect, and you might pay for their mistakes. Sometimes when someone rolls over an IRA or other retirement plan to a new IRA, the custodian makes a mistake and puts the money in a non-IRA account. This triggers taxes if not reversed promptly. Or a transfer might go into the wrong account. Requests for required minimum distributions might be made in the wrong amount, leaving you to pay a penalty for not distributing enough. You may be able to obtain a waiver of the penalty from the IRS when the mistake was not your fault, but you have to apply and wait to hear if the IRS approves the waiver.

Another disadvantage of some custodians is they prevent you from doing things the tax law allows or impose fees for doing them.

Spousal rollovers. A spouse who inherits an IRA is allowed to roll it over to his or her own IRA. This allows the spouse to start a new distribution schedule and select new beneficiaries. Some custodians make it difficult for the spouse to make a transfer. They allow a transfer only to an IRA with the identical legal owner. So, at the new custodian your surviving spouse must set up an IRA with the same title as the inherited IRA, roll over the original IRA to the new IRA, and then roll over that IRA to an IRA in his or her own name.

Multiple IRAs. The tax law allows you to have as many IRAs as you want. You can split your IRA so each IRA has a separate beneficiary. Or when you leave one IRA to multiple beneficiaries (say, equal shares to each of your children), they are allowed to split it into separate IRAs for each of them. Yet, though the tax law allows these moves, a custodian doesn’t have to allow multiple IRAs or can impose fees for each of them. You might want to review your custodian’s policy on this matter to be sure your beneficiaries will be able to take full advantage of the tax law’s benefits.

Inheritance issues. When an IRA is inherited, some custodians after receiving notice automatically change the name on the IRA to the beneficiary’s name. Doing this takes away the tax deferral of the IRA, requiring the account to be distributed in a short time. The title must have the names of both the deceased owner and the new beneficiary. Other custodians will automatically distribute the balance of an IRA if the original owner already began distributions under a schedule. That action is not required by the tax law. The beneficiary may continue distributions under the schedule or take distributions over his or her life expectancy. Some custodians, after receiving notice of the owner’s death, simply close the account and issue a check to the beneficiary — triggering taxes on the beneficiary. Again, check your custodian’s policy on handling IRAs after the owner passes away.

Executor communications. The executor is the person who administers your estate and takes it through probate. Your will and estate, though, do not determine who inherits the IRA. Only the beneficiary designation form you file with the custodian does. The IRA avoids probate. Because of this, some custodians will not communicate with the estate executor but only with the beneficiary of the IRA. This can make it difficult for the executor to prepare the estate tax return and perform other duties. Ask your custodian about its policy on communicating with executors and beneficiaries. If specific paperwork will be required, be sure your executor knows the rules.

Don’t expect more from an IRA custodian than it plans to deliver. When you have any doubts about the custodian’s services, duties, or policies, call and confirm. Review your IRA transactions carefully to ensure they are executed properly. Once your estate plan is set, verify with the custodian that it will help implement the details of the plan and won’t charge extra fees. Otherwise, look for another custodian to hold your IRA. There are plenty of IRA custodians out there. There’s no reason to keep your IRA with a custodian who limits your options.

Similar Posts:

• Conversion to Roth IRA
• How to Trade Commodities Online
• Moody’s places U.S. on review for downgrade as debt talks stall
• What you need to know about trading commodities online
• Mass. City to Pay Stipend to Married Gay Workers