Costs include legal fees to draft the contract, custodian fees and an appraisal to substantiate the valuation adjustment. At least one bank is reportedly studying whether it is feasible to charge a reduced asset management fee on RMAs, since the account can't leave for the contract term.
Potential Transfer And Income Tax Benefits
RMA discounts vary from case to case depending upon the particulars of the contract and the assets held at appraisal. Agreements covering longer periods deserve heftier discounts, for instance, and perhaps so do accounts that own illiquids or products with rapacious exit fees. A key factor is whether RMA income (which is taxable currently to the client) is retained within the account or is distributed to the extent of the income tax bill it generates. "The discount will be greater if there are no distributions for taxes," Handler says. Here's how the discount plays out:
At death, Lauterbach explains, if the RMA owns assets valued at $5 million and it is entitled to a 25% discount, the account's value for federal estate tax purposes is $3.75 million. In this case, the valuation adjustment saves as much as $600,000 in death tax. Although the RMA can't be touched to pay any tax due, its discount reduces the client's liquidity needs at death, potentially impacting other parts of the financial plan, says Lauterbach.
In the IRA context, the RMA discount may save the client income taxes during her life, according to Such. A discounted account value produces lower minimum required distributions (since they are a function of the account value). That suppresses the client's income, lowering taxes, Such says.
Practical Considerations
For the independent advisor, the first step is to locate a willing and capable trust company. Although an RMA is a contract, its legal implications are wide-ranging. "Securities laws, banking law issues, income, gift and estate tax issues-all of those come into play," says Handler, who has helped develop agreements for Wachovia Bank and Citigroup. The advisor's due diligence on institutions offering the accounts includes asking whether experts from the various disciplines were involved in the drafting of the contract.
Advisors should also ensure that the institution intends to honor its agreement to not disburse funds from any of its restricted accounts, regardless of how badly an important customer needs cash. "If a bank or trust company gives a client his money back before the contract ends, that jeopardizes the validity of the (institution's) contract for all of its clients, not just that one," Handler says.
The RMA account should be registered to a single owner in order to obviate certain valuation rules applicable to partnerships under Internal Revenue Code Chapter 14, a favorite IRS attack route. Advisors to married clients in community property states should seek local counsel regarding the implications for RMA account ownership.
Beyond that, all you have to do is manage for the long term.
Newcomer And The Aging Champ: RMA Vs. FLP
Restricted management accounts have quietly been gaining currency in direct proportion to watershed victories by the IRS in its war against the once-invincible family limited partnership. Strangi II, Kimbell and other recent cases show that FLP clients really can't retain control if they are to reap a valuation discount, nor can they ignore the entity's formalities.
The latter is not an issue with an RMA. It's a contract-there are no meetings to hold and document, or annual tax filings. So it's simpler and less costly to create and administer.