Back in 2009, I wrote an article I called, “The Dummy Contract.”
The gist of the article, every day we are being presented contracts to sign and 90% of the time we sign them without being the slightest bit aware of the legal consequences. One of the examples I gave in that article involved IRA agreements.
Typically when we open up a brokerage account for our IRA, the brokerage firm requires us to sign a “dummy contract” agreeing to either indemnify the firm, for any losses or pledge any personal accounts we have with that firm as collateral, in the event the IRA goes upside down. It’s amazing they even ask for indemnification or a lien on your other assets, because after all, how can an IRA invested in the stock market, mutual funds, or bonds go upside down?
Here’s the big challenge, even though we were assured that the firm or its representatives had our best interests at heart. . . the firm or its representatives were IRA experts. . . the firm or its representatives were there to make us successful. . . the firm or its representatives “in reality” probably caused us to lose our IRA.
Let me make it even more clear. You, your clients, your family, your neighbors, etc . . . . probably no longer have IRAs. If you signed the “dummy contract”, you have caused the IRA to be fully distributed and instead of building up a tax deferred nest egg, you are building up a massive tax liability that is growing more and more each and every year.
Sure, we’ve all been brainwashed to think we have an IRA. Yep, we get incorrect account statements saying we have IRAs as well, but we don’t.
What backup do I have for my assertion?
Bear with me as I explain. A few years back I was giving a presentation to the local estate planning council, and a broker who worked at one of the big wire houses, came up to me and said they would like to work with me on some projects. Being the gracious person I am, I said I would love to, but just wanted to review their IRA docs to make sure they were fully compliant.
As I read the IRA docs, it became painfully obvious that anyone who signed these documents would cause their IRA to be distributed. I told that to the broker, who just chuckled and said they were pretty sure their attorneys were aware of the issue. After looking at a bunch of other brokerage house docs, I found out they all pretty much had the same boilerplate language. That same exact language caused a distribution of someone’s IRA.
Finally in 2008, I asked the Department of Labor (little known fact, DOL is in charge of interpreting certain rules for IRAs, the IRS is merely the enforcer) for an Opinion as to whether my opinion that the account applications were causing distributions was correct or not. In 2009, the DOL issued Advisory Opinion 2009-03A saying that if an individual personally guarantees their IRA, that would be considered an extension of credit between the individual and their IRA, which creates something called a prohibited transaction.
Under the tax code, if an IRA engages in a prohibited transaction, that means it is considered completely and fully distributed. By the way, this isn’t rocket science. Anyone who professes to have some expert knowledge in the area of IRAs should be on top of the various DOL Opinions and thus should be aware of this issue. Having said that, when was the last time your IRA guru shared this info with you?
Take a second or even an hour to review the account application and brokerage agreement that you signed or if you are a financial advisor, had your clients sign, in order to open an IRA. Do you see the words indemnify, pledge, or security anywhere? If you do, there is a very high likelihood the account is no longer an IRA.
By the way, if you are contemplating a Roth conversion you should really take note. It’s necessary to have an IRA in order to convert to a Roth IRA. If the IRA’s status was blown by some stupid account agreement, there is no traditional IRA to convert to a Roth. At this point the only growth occurring in the account will be 6% excess contribution penalties on the amount you thought you converted.
Ok, so that is the bad news. Is there a solution?
What typically pops into a lot of people’s minds right now is S.O.L. No, no, I’m not talking about some profane phrase; rather I’m talking about the Statute Of Limitations. Bad news here, I went through about a six month debate about this very subject with the IRS, the IRS was of the opinion I was being a tax shelter promoter by even talking about the subject. I don’t think you’ll be surprised to know that the IRS feels the SOL does not apply in this case and thus the taxes and penalties aren’t going to just disappear.
How do you fix the disaster?
Contrary to popular belief, the IRS really does want to help people become compliant. A direct result is the IRS has a rehabilitation program whereby if you knock on the IRS’s door before they knock on yours; they can pretty much grant clemency to the IRA and forgive past transgressions. The program doesn’t work for everyone, but will work for about 90% of the cases out there.
By the way, those of you who are financial advisors or insurance agents are really going to want to learn a lot more about this, as not only can you help a ton of people out, but you can also use this powerful knowledge to gather more clients. We are considering a workshop about this subject in Las Vegas. It isn’t going to be a freebie workshop as we are going to share with you some incredibly powerful tools to help out your business.
If you have an interest please fill out this contact form.