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Physician Creditor Protection for IRAs, Annuities and Insurance for 2014-15

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A SPECIAL ME-P REPORT

###

Asset Protection Planning for Qualified and Non-Qualified Retirement Plans, IRAs, 403(b)s, Education IRAs (Coverdell ESAs), 529 Plans, UTMA Accounts, Health/Medical Savings Accounts (MSA/HSAs), Qualified and Non-Qualified Annuities, Long-Term Care Insurance, Disability Insurance and Group, Individual and Business Life Insurance [Ohio Focus]

By Edwin P. Morrow III; JD LLM MBA CFP® RFC®

[©2007-12-14. All rights reserved. USA]

EDITOR’S NOTE:

Hi Ann,

A couple years ago you posted an earlier version of the attached Asset Protection Outline. I updated it to include quite a bit more discussion of different protection levels for various kinds of accounts, and included more discussion of states other than Ohio, including a 50 state chart with IRA/403b protections.

So please delete the old one and replace with this one which contains more topics, including some substantial discussion of issues regarding current class action litigation jeopardizing asset protection for Schwab and Merrill Lynch IRAs.

Regards
Ed

###

The Importance of Asset Protection as Part of Financial and Estate Planning for Doctor’s and Medical Professionals

Asset Protection has become a ubiquitous buzz-word in the legal and financial community. It often means different things to different people. It may encompass anything from buying umbrella liability insurance to funding offshore trusts.

What is most likely to wipe out a client’s entire net worth? An investment scam, investment losses, a lawsuit, divorce or long-term health care expenses? “Asset Protection” may be construed to address all of these scenarios, but this outline will cover risk from non-spousal creditors as opposed to risk from bad investments, divorce, medical bills or excessive spending. Prudent business practice and limited liability entity use (LP, LLP, LLC, Corporation, etc) is the first line of defense against such risks. Similarly, good liability insurance and umbrella insurance coverage is paramount.

However, there is a palpable fear among many of frivolous lawsuits and rogue juries [especially among physicians and medical professionals]. Damages may exceed coverage limits. Moreover, insurance policies often have large gaps in coverage (e.g. intentional torts, “gross” negligence, asbestos or mold claims, sexual harassment).

As many doctors in Ohio know all too well, malpractice insurance companies can fail, too. Just as we advise clients regarding legal ways to legitimately avoid income and estate taxes or qualify for benefits, so we advise how to protect family assets from creditors. Ask your clients, “What level of asset protection do you want for yourself?

For the inheritance you leave to your family?” Do any clients answer “none” or “low”? Trusts that are mere beneficiary designation form or POD/TOD substitutes are going out of style in favor of “beneficiary-controlled trusts”, “inheritance trusts” and the like.

Table of Contents

While effort is made to ensure the material is accurate, this material is not intended as legal advice and no one may rely on it as such. Sections II(d), II(i), V, VI and XI were updated Feb 2012, but much of the material and citations have not been verified since 2010. Permission to reprint and share with fellow bar members is granted, but please contact author for updates if more than a year old.

T.O.C. [Page Number]

I. Importance of Asset Protection 2

II. State and Federal Protections Outside ERISA or Bankruptcy 4

a. Non-ERISA Qualified Plans: SEP, SIMPLE IRAs 5

b. Traditional and Roth IRAs, “Deemed IRAs” 7

c. Life Insurance 9

d. Long-Term Care, Accident/Disability Insurance 13

e. Non-Qualified Annuities 13

f. Education IRAs (now Coverdell ESAs) 16

g. 529 Plans 17

h. Miscellaneous State and Federal Benefits 18

i. HSAs, MSAs, FSAs, HRAs 18

III. Federal ERISA Protection Outside Bankruptcy 20

IV. Federal Bankruptcy Scheme of Creditor Protection 26

V. Non-Qualified Deferred Comp – Defying Easy Categorization 30

VI. Breaking the Plan – How Owners Can Lose Protection 32

(incl Prohibited Transactions and Schwab/Merrill Lynch IRA problems) 35

VII. Post-Mortem – Protections for a Decedent’s Estate 51

VIII. Post-Mortem – State Law Protections for Beneficiaries 52

IX. Post-Mortem – Bankruptcy Protections for Beneficiaries 54

X. Dangers and Advantages of Inheriting Through Trusts 56

XI. Piercing UTMA/UGMA and Other Third Party Created Trusts 59

XII. Exceptions for Spouses, Ex-Spouses and Dependents 61

XIII. Exceptions when the Federal Government (IRS) is Creditor 62

XIV. Fraudulent Transfer (UFTA) and Other Exceptions 68

XV. Disclaimer Issues – Why Ohio is Unique 69

XVI. Medicaid/Government Benefit Issues 71

XVII. Liability for Advisors 72

XVIII. Conflicts of Law – Multistate Issues 73

XIX. Conclusions 75

Appendices

A. Ohio exemptions – R.C. §2329.66 (excerpt), §3911.10, §3923.19 78

B. Bankruptcy exemptions – 11 U.S.C. § 522 excerpts 80

C. Florida IRA exemption – Fla Stat. § 222.21 (note-may be outdated) 85

D. Sal LaMendola’s Inherited IRA Win/Loss Case Chart 86

E. Multistate Statutory Debtor Exemption Chart 88

###

Assessment

This outline will discuss the sometimes substantial difference in legal treatment and protection for various investment vehicles and retirement accounts, with some further discussion of important issues to consider when trusts receive such assets.

Beware of general observations like: “retirement plans, insurance, IRAs and annuities are protected assets” – that may often be true, but Murphy’s law will make your client the exception to the general rules. The better part of this outline is pointing out those exceptions.

2012 WHITE PAPER LINK:

Creditor Protection for IRAs Annuities Insurance Nov 19 2010 WC CLE Feb 2012 update

***

2014 WHITE PAPER LINK UPDATE:

Optimal Basis Increase Trust Aug 2014

***

ABOUT THE AUTHOR:

Mr. Edwin P. Morrow III, a friend of the Medical Executive-Post, is a Wealth Specialist and Manager, Wealth Strategies Communications Ohio State Bar Association Certified Specialist, Estate Planning, Probate and Trust Law Key Private Bank Wealth Advisory Services. 10 W. Second St., 27th Floor Dayton, OH 45402. He is an ME-P “thought leader”.

Constructive criticism or other comments welcome.

Conclusion

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Tax Strategies for Retiring Medical Professionals

Some Valuable Tips for 2011

By Sean G. Todd, Esq., M. Tax, CFP©, CPA 

www.EMCAdvisors.com

We need to start this ME-P with the famous quote made by Benjamin Franklin almost 300 years ago and yet still rings true: 

Nothing in life is certain except death and taxes.”

I believe physicians and all individuals better be formulating a tax-efficient investment and distribution strategy. Here is why: as a physician retiree or planning-to-be retired, with an effective tax strategy, you will keep more of your hard-earned assets for yourself and your heirs. Here are a few items for consideration which just might help with your money management during your later years.

The General “Rules”

1.  Utilize Tax Efficient Investments

Municipal bonds or “munis” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well. The higher your tax bracket, the more you may benefit from investing in munis. This is not the “silver bullet” to retirement income planning. Yet, we see unknowing investors being exposed to a significant downside risk which could result in significant losses of their assets.

2.  Utilize Tax Efficient Mutual Funds/Index Funds

A more acceptable point is that all mutual funds are not created equal. A prudent move might be to reallocate part of your portfolio to start investing in tax-managed mutual funds. Managers of these funds pursue tax efficiency by employing a number of strategies. For instance, they might limit the number of times they trade investments within a fund or sell securities at a loss to offset portfolio gains. Equity index funds may be even more tax-efficient than actively managed stock funds – having the ability to identify which index fund(s) are being more tax efficient is where we come in.

It’s also important to review which types of securities are held in taxable versus tax-deferred accounts. Why? Because in 2003, Congress reduced the maximum federal tax rate on some dividend-producing investments and long-term capital gains to 15%. In light of these changes, many financial experts recommend keeping real estate investment trusts (REITs), high-yield bonds, and high-turnover stock mutual funds in tax-deferred accounts. Low-turnover stock funds, municipal bonds, and growth or value stocks may be more appropriate for taxable accounts.

A Comparison Chart

Just for ease of comparison on a pure return basis, I thought the following chart would make a great reference.  Would a tax-free bond be a better investment for you than a taxable bond? Compare the yields to see. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.

Federal Tax Rate 15% 25% 28% 33% 35%
Tax-Exempt Rate Taxable-Equivalent Yield
4% 4.71% 5.33% 5.56% 5.97% 6.15%
5% 5.88% 6.67% 6.94% 7.46% 7.69%
6% 7.06% 8% 8.33% 8.96% 9.23%
7% 8.24% 9.33% 9.72% 10.45% 10.77%
8% 9.41% 10.67% 11.11% 11.94% 12.31%

*The yields shown above are for illustrative purposes only and are not intended to reflect the actual yields of any investment. 

3.  A question we get frequently: Which Security to Tap First?

A successful retirement plan is largely based on a sustainable income stream. This type of financial planning requires a specific set of skills. To facilitate a consistent income stream, another major decision is when to liquidate various types of assets.  The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have a greater earning potential than their taxable counterparts.

Consideration must also be given to making qualified withdrawals from tax-deferred investments which are taxed at ordinary federal income tax rates up to 35%, while distribution, in the form of capital gains or dividends, from investment in taxable accounts are taxed at a maximum 15% [Capital gains on investments held for less than one year are taxed at regular income tax rates].

This reason makes it beneficial to hold securities in taxable accounts long enough to qualify for the 15% rate.  When the focus is on estate planning, long term capital gains are more attractive because the beneficiary will receive a step-up in basis on appreciated assets inherited at death.
Another consideration when developing the sustainable retirement income plan is the timeframe for tapping into tax-deferred accounts.  Keep in mind, the deadline for taking required annual minimum distributions (RMDs) and have you taken into account the possible impact of the proposed tax law changes on your retirement income distribution plan?

4.  The Ins and Outs of RMDs

The IRS mandates that you begin taking an annual RMD from traditional IRAs and employer-sponsored retirement plans after you reach age 70 1/2. The premise behind the RMD rule is simple — the longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year. RMDs are now based on a uniform table, which takes into consideration the participant’s and beneficiary’s lifetimes, based on the participant’s age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount.

Inside Tip: Why you should not wait until you retire to develop a sustainable retirement income plan: If you’ll be pushed into a higher tax bracket at age 70 1/2 due to the RMD rule, it may pay to begin taking withdrawals during your sixties. Unlike traditional IRAs, Roth IRAs do not require you to begin taking distributions by age 70 1/2. In fact, you’re never required to take distributions from your Roth IRA, and qualified withdrawals are tax free. For this reason, you may wish to liquidate investments in a Roth IRA after you’ve exhausted other sources of income. Be aware, however, that your beneficiaries will be required to take RMDs after your death. 

Estate Planning and Gifting

Attaining proper investment counsel and advice has to answer the question—-“What happens when I die?”  Many strategies can be implemented by clients to address the various ways to make the tax payments on your assets easier for your heirs to handle. Who is the proper beneficiary of your money accounts?  If you do not name a beneficiary, your assets could end up in probate, and your beneficiaries could be taking distributions faster than they expected.

In most cases spousal beneficiaries are ideal, because they have several options that aren’t available to other beneficiaries, including the marital deduction for the federal estate tax, and the ability to transfer plan assets — in most cases — into a rollover IRA.

Also consider transferring assets into an irrevocable trust if you’re close to the threshold for owing estate taxes based on the sunset provisions.  Best estate tax avoidance plan today – die in 2010 as there is no limit on the amount you can pass to the next generation estate tax free.  Assets in this type of arrangement are passed on free of estate taxes, saving heirs tens of thousands of dollars.

Inside Tip: If you plan on moving assets from tax-deferred accounts do so before you reach age 70 1/2, when RMDs must begin.

Finally, if you have a taxable estate, you can give up to $13,000 per individual ($26,000 per married couple) each year to anyone tax free.  If you need my contact information, please let me know.  Also, consider making gifts to children over age 14 as dividends may be taxed — or gains tapped — at much lower tax rates than those that apply to adults.

Inside Tip: You may want to consider a transfer of appreciated securities to custodial accounts (UTMAs and UGMAs) to help save for a grandchild’s higher education expenses.

Market Focus

As individuals, especially doctors living in mini-mansions, come to grips with not being able to sell their homes for a value they once thought possible, we are apt to suggest that we might see increased activity in the home improvements sector as individuals just decide to make the upgrade to their existing home while they wait this whole real estate mess out. 

How can all this help you financially?  You are seeing exactly why you cannot base your investment decisions on the latest headline or try to time the market  Single and doubles in the investment world will score more runs than trying to to hit a home run (timing the market). What is your singles and doubles strategy? 

Summary

  • Formulating a tax-efficient investment and distribution strategy may allow you to keep more assets for you and your heirs.
  • Consider tax-efficient investments, such as municipal bonds and index funds, to help reduce exposure to taxes.  It’s what you keep that counts.
  • Tax-deferred investments compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts. However, qualified withdrawals from tax-deferred investments are taxed at income tax rates up to 35%, whereas distributions from taxable investments held for more than 12 months are taxed at a maximum 15%.
  • You must begin taking an annual amount of money (known as a required minimum distribution) from some tax-deferred accounts after you reach age 70 1/2.
  • Review how your assets fit into a comprehensive estate plan to make the most of your money while you’re alive and to maximize the amount you’ll pass along to your heirs.
  • Before selling appreciated investment assets, be sure that you have owned them for at least one year. That way, you’ll qualify for lower capital gains taxes.
  • If you’re considering placing assets in a trust or custodial account, think carefully about which assets would be most appropriate to transfer.
  • Schedule a meeting with a financial professional to review your tax management strategies.
  • Remember to begin taking required minimum distributions from traditional IRAs and employer-sponsored retirement accounts after you reach age 70 1/2 in order to avoid costly penalties.

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