On February 21 and again on March 12, the U.S. Courts of Appeals for the Ninth and Fifth Circuits, respectively, ruled that inherited IRAs are exempt from the bankruptcy estate and thus protected from creditors. These are the first inherited IRA victories at the circuit court level. (The Ninth Circuit covers California, Nevada, Arizona, Oregon, Washington, Idaho, and Montana. The Fifth Circuit covers Texas, Louisiana, and Mississippi.)

However, recent developments in the Senate might indirectly render these and all past favorable inherited IRA decisions moot. How? By limiting the non-spouse stretch-out to 5 years (for deaths after December 31, 2012). Senator Max Baucus (D - Montana) has proposed the same twice already this year and Senator John Kyl (R - Arizona) reportedly agrees with the idea. Such a limited stretch-out would not only mean substantially greater income taxes, but also far less creditor protection since the same depends on the funds being in the inherited IRA.

So far, Senator Baucus's proposals have gone nowhere. But, if the stretch-out is eventually so limited, counter-measures include CRUTs, ILITs and discretionary trusts coupled with Roth conversions, as follows:

Even versus a full stretch-out, CRUTs can provide superior net-after-tax results because they can pass capital gains through to heirs. Inherited IRAs cannot. If the stretch-out is limited, CRUTs would look even better.

As would pulling more out now from a plan to fund an ILIT. This would cover a bequest of the plan to charity (or to the plan owner's private foundation). The bequest would be income and estate tax free. So would the ILIT policy proceeds - and creditor-protected too.

Finally, with a limited stretch-out, rather than customized stretch-out trusts like conduit trusts in use now, discretionary trusts should be used instead. Leaving Roth IRAs to the same would avoid all trust income taxation. Further, death-bed Roth conversions could save estate taxes too.

As always, we will keep you apprised of developments as they occur in the courts and the Congress this year.

For more information regarding this topic, please e-mail your requests to Salvatore J. LaMendola, or call Sal at (248) 457-7204.

On February 1, 2008, Fran Schuber, then 83, and her boyfriend made an unsolicited visit to Lakeport, California life insurance agent Glenn Neasham. Ms. Schuber had a $239,000 Certificate of Deposit maturing at the end of that month and visited Mr. Neasham to discuss the possibility of purchasing an Allianz indexed annuity which Ms. Schuber's boyfriend had purchased the previous year. After a discussion with both of them and Ms. Schuber's son, Ms. Schuber decided to purchase a $75,000 MasterDex 10 indexed annuity from Allianz. Notably, this annuity was approved by Allianz to be sold to people up to 85 years old.

This indexed annuity had an initial surrender charge of 12.2% although Ms. Schuber could either annuitize or get a guaranteed monthly annuity payment or could draw 10% per year without penalty. Mr. Neasham was aware of the potential for abuse and made certain that the annuity was suitable for Ms. Schuber and complied with California's Senior Protection law which was passed to protect seniors against inappropriate sales. At his jury trial, Mr. Neasham testified that no one, including Ms. Schuber's son, mentioned dementia or Alzheimer's.

Meanwhile, when the money was removed from the Certificate of Deposit at the end of February, 2008, the manager at the bank where Ms. Schuber's CDs were located contacted Adult Protective Services (APS). There is a California law entitled "Financial Elder Abuse Reporting Act of 2005" which requires all bank employees to report suspected elder abuse, or face $5,000 in penalties. The Lake County APS involved its District Attorney's Office which led to an interview of Ms. Schuber. Instead of pressing charges, the District Attorney's office referred the case three months later to the California Department of Insurance. A department investigator met with Ms. Schuber for 30 minutes in December of 2008 during which Ms. Schuber apparently showed signs of dementia, according to the investigator.

Two years later - on December 14, 2010 - Glenn Neasham was arrested and charged with felony theft from an elder or dependent adult of an amount exceeding $950. A jury trial was set for September 21, 2011. During the trial, seven defense witnesses were brought in. One witnesses, a noted author on annuities, testified that an Allianz MasterDex 10 is complicated but "has many more benefits than there are negatives" and "not everyone wants liquidity". He also testified that he would, in fact, be happy to buy Ms. Schuber's annuity for at least $180,000 - $5,000 more then she paid for it.

The prosecution argued that Mr. Neasham was motivated by a $14,000 commission and that Ms. Schuber was denied access to her money because of the annuity. On October 21, 2011, Glenn Neasham was found guilty by the jury on felony theft charges. He was subsequently sentenced to 300 days in jail, which was later reduced to 60 days. California's Department of Insurance summarily revoked Mr. Neasham's insurance license on March 9, 2012.

Mr. Neasham reportedly has stated that the case has ruined him financially and he will have to be represented by a public defender for his appeal. He has lost his business and his family is now on food stamps.

While the charges were brought in California, this case illustrates the potential for a chilling effect on annuity sales to elderly individuals. Particularly disturbing is the fact that the annuity in question was approved by the State of California for sale to someone up to the age of 85. The annuity was approved by Allianz Insurance Company. Additionally, Ms. Schuber suffered no financial harm in the end because her conservator, in January of this year, ultimately cashed out the annuity at which point Allianz returned the principal with interest and without any penalties.

This case also illustrates significant risks faced by life insurance producers who sell insurance products in states which have passed broadly written elder-abuse laws, such as Michigan. Financial advisors who find themselves in similar circumstances should take particular care.

For more information regarding this topic, please e-mail your requests to Thomas P. Cavanaugh, or call Tom at (248) 457-7218.

More than a third of high-net-worth individuals don't have confidence in their beneficiaries to handle their inheritance responsibly, according to a new study by Barclays Wealth. The survey canvassed more than 2,000 individuals in 20 countries, each of whom had more than $1.5 million in investable assets, and 200 with more than $15 million. However, 96% of survey respondents said they still plan to leave their fortunes to their children, with 70% saying they would divide their inheritances equally among beneficiaries.

The high level of distrust that parents expressed about their heirs' ability to manage their inheritance suggests the importance of using trusts as part of a comprehensive estate plan. In fact, 60% of respondents said they will require a high level of professional advice as they establish an estate plan for their children. Nevertheless, 23% of individuals surveyed said that they don't have a will - a remarkably large number, given the high net worth of the respondents!

This study indicates the need for estate planners to counsel their clients on estate plans that avoid a lump-sum windfall to the beneficiaries in order to protect them from their inability, their disability, their creditors and their predators, including ex-spouses. The estate plan should also encourage the heirs to work hard to advance their own careers (as opposed to waiting for an inheritance that may not come until the heirs are past retirement age). Finally, to the extent possible, the estate plan should take maximum advantage of the parents' generation-skipping tax exemption in order to minimize the estate tax as trust assets pass from one generation to the next.

Trusts can take on many forms. Incentive trusts, for instance, can be structured so that whatever the children earn on their own, the trust will match. Incentive trusts can also encourage (reward) other types of behavior important to the parents (i.e., graduating from college, getting married, having a baby, etc.). Many parents opt for a trust structure with trustees who can make discretionary payments to beneficiaries on an as-needed basis for health, education, maintenance and support. Those trusts can protect the grantor's children (and more remote descendants) from creditors and ex-spouses - in perpetuity (depending on state law). Still other parents prefer a staggered distribution model where beneficiaries receive defined payouts as they reach certain ages (i.e., one-third at ages 25, 30 and 35). All of these models allow beneficiaries to enjoy wealth, but not in an unfettered manner.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.