IRAs are a big business for many financial planners who focus on retirement planning.
However, there are liability headaches that advisors should consider. Take the following scenario:
Let’s say Jack is a financial planner who finds a new prospect who has $50,000 in a CD IRA at a local bank.
Jack is interested in investing the $50,000 and merely tells the IRA owner to withdraw the $50,000 amount from her CD, which is about to mature. The IRA owner, Mary, 75 years of age, is not sophisticated and withdraws the $50,000 from her IRA.
Unfortunately, Jack fails to tell the IRA owner that she will owe income taxes on the IRA distribution. Jack does not tell her about any rollover options.
At income tax time, the IRA owner is told by her tax preparer that she now owes $15,000 in additional income taxes, triggered by the IRA distribution.
Question: Is Jack vulnerable to any liability? Answer: You bet.
In arbitration proceedings the financial planner can be held liable because of the failure to tell his unsophisticated client about the tax consequences of an IRA distribution.
Here are several more examples of errors that may result from improper IRA advice.
A CPA in New York State is engaged by an IRA beneficiary to give advice regarding an inherited IRA. The CPA did not know the stretch payment rules and told the client that the five-year rule was operative, rather than the life expectancy rule. He received $400 for his advice. He was sued for giving incorrect advice and stated in a deposition that, in essence, he had no idea as to the proper IRA rules. The settlement paid by his malpractice carrier was $25,000!
An attorney in New York state handling an estate matter was asked how to handle an inherited IRA of about $500,000. He advised the beneficiary to just take it out. Ultimately, in an arbitration proceeding, the attorney was held liable to the tune of about $250,000 for failing to know the IRA distribution rules.
A financial planner in Florida tells an unsophisticated and elderly client to withdraw about $30,000 from a CD IRA.
The client does so and goes to her tax preparer. She finds out she owes $9,000 in additional income taxes on the IRA distribution.
This situation ultimately went to arbitration in the case of Marilyn Green and Melissa Green vs. LPL Financial.
One of the allegations against LPL Financial was that the LPL broker never advised the client about the income tax consequences of the IRA distribution. A number of additional allegations were made as well.
The attorney representing the claimants was Jon A. Jacobson of West Palm Beach, Fla.
The arbitrator’s decision, made on Nov. 10, 2015, granted the claimants an award in the amount of $52,062 and included:
1. Compensatory damages: $10,260
2. Treble damages: $21,240 (double the $10,620)
3. Attorney fees: $20,202
According to Jacobson, brokers and firms in a number of FINRA cases can be held liable for failing to advise their clients about the tax consequences of transactions that they recommend.
Imagine the liability for practitioners such as accountants, attorneys and financial planners who give advice regarding IRA matters, but don’t know the intricate IRA rules.
An attorney drafts what he thinks is an IRA and retirement benefit QTIP (Qualified Terminable Interest Property) trust. It turns out that the trust does not satisfy Rev. Rul. 2006-26. As a result the $2,500,000 payable to the trust is subject to an estate tax liability of over $1,000,000.
The client decides not to sue the attorney.
An attorney drafts a noncompliant IRA trust that is part of a testamentary trust. As a result the stretch payment of over $7,000,000 is lost.
For technical reasons the trustee decides not to sue the attorney.
The trustee of an IRA trust fails to timely file the IRA post-death trust documentation paperwork with the IRA institution by the October 31 deadline date. The deadline is October 31 following the year of death of the IRA owner. The result is the stretch payment of the trust beneficiary is lost.
The real problem is that many IRA account holders are passing away with substantial retirement accounts. The attorney for the estate may be a great probate lawyer but may not know all the post-death IRA rules and IRA penalty issues. If the beneficiaries of the estate are also beneficiaries of the IRA, they may ask the attorney for post-death IRA advice. If the attorney gives the wrong advice, then the attorney has potential liability. If the attorney tells the IRA beneficiary to go to their accountant for advice and the accountant gives the wrong advice, then the accountant has a problem. If the attorney and accountant are connected through some type of relationship, then they both can have professional liability if the wrong advice is given.
One wonders how a financial planner, attorney or accountant can know all the complex rules regarding IRAs. These IRA rules require the advisor to have knowledge regarding traditional IRAs, Roth IRAs, the multiple non-spouse inherited IRA rules, the rollover rules, the IRA excise tax rules, the year of death RMD rules, the IRA trust rules and many other rules. The bottom line is that very few people are IRA gurus and know the subject area.
The real bottom line is that if you don’t know the area, then don’t mess with it.
Seymour Goldberg, CPA, MBA, JD a senior partner in the law firm of Goldberg & Goldberg, is Professor Emeritus of Law and Taxation at Long Island University.
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