When decisions are impaired by disability

In following self-imposed restrictions on her IRA distributions, a bipolar investor recently learned from the IRS that her actions would not cause any adverse tax consequences. Here's the story: “John” and “Jane” got divorced, and as part of their agreement, Jane was entitled to half of John's individual retirement account. Jane previously had been diagnosed with bipolar disorder, a condition that could affect her judgment in handling funds, including those from the newly received IRA. In order to protect Jane from her own potentially poor decisions and im-prudent actions, a series of directives were drafted that would be given to Jane's custodian to help provide at least a minimal amount of control over her funds. The instructions included provisions that all distributions from Jane's IRA be deposited electronically into Jane's bank or investment account and that required minimum distributions be distributed ratably in monthly installments. If Jane wanted a distribution above the required minimum amount, she would have to request it in writing, and there would be a 30-day waiting period. Furthermore, notice of such a request would have to be provided to Jane's attorney or personal representative, in writing or via e-mail, at least 21 days prior to making the additional distributions, presumably to give him or her time to prevent an inadvisable use of funds. An additional directive also was included allowing Jane's attorney or her personal representative to request a distribution on her behalf, without a waiting period, in the event of a medical emergency. Jane's directions could be changed by a written request, but such changes would not take effect for at least 30 days after receiving the request. Furthermore, notice of such a change would be furnished to Jane's attorney or personal representative in writing or via e-mail at least 21 days prior to making the changes — again, a step likely taken to allow such an individual to intervene on Jane's behalf, preventing a misuse of funds. Finally, the rules would not apply to Jane's heirs after her death. Clearly, this was a somewhat unusual request. Either Jane's tax adviser or the proposed IRA custodian must have been concerned about the potential tax consequences of these protective directives and advised Jane to submit a private letter ruling to the Internal Revenue Service requesting that the IRA not be disqualified because of the conditions and restrictions. The IRS ruled that Jane's IRA would not be disqualified. First, the agency addressed the transfer of John's IRA to Jane, noting that it was nontaxable because it was triggered not by any asset protection planning but pursuant to a divorce agreement. Such transfers are allowed under the law. As such, the IRS reasoned that the transfer could not be a prohibited transaction. The agency next addressed whether Jane's self-imposed limitations on distributions would cause the portion of Jane's IRA balance exceeding her annual required minimum distribution and/or any balance remaining after her death to be treated as an impermissible forfeiture or assignment. This was a significant concern because any portions of an individual's IRA that are deemed to be assigned to another individual or entity are treated as being distributed to the IRA owner, resulting in a taxable event. Thankfully for Jane, in the IRS' view, this was not an issue. As it pointed out, IRAs are subject to required minimum distributions on an annual basis (once owners reach 701/2), but as long as an IRA owner takes the minimum amount required each year and the IRA itself complies with the qualification requirements outlined in the tax code, no penalties are assessed. Jane's instructions not only did not restrict or prevent any of her RMDs from being properly taken, but they actually explicitly required that such distributions take place. Therefore, in the view of the IRS, although Jane's directives were restricting her access to her IRA funds, they did not violate the law. In fact, they were no less restrictive than what “regular” IRA owners might choose on their own if they wanted to take only the minimum amounts each year. The plan devised by Jane and her custodian was a balance between control and tax planning, and since the petition was successful on all accounts, it's possible that we may begin to see similar types of arrangements in the future. Ed Slott (irahelp.com), a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace.