Make sure clients are accessing their accounts or otherwise taking steps that would deem their accounts active
Can the state really make off with your client’s IRA? Yes! It’s called escheatment and states have been using this tactic more aggressively to bring in money. In a recent private letter ruling (PLR 201611028, released by IRS on March 11, 2016), the IRS allowed a taxpayer to complete a late 60-day rollover after his IRA was escheated by his state. Ultimately, the taxpayer was able to recover his IRA from the state and avoid taxation on his distribution, but not without first exhausting a great deal of time and money.
“Peter” had two IRA accounts, IRA A and IRA B. For some reason, Peter stopped receiving statements for IRA B, so from time to time, he would go to the bank holding the account and find out what the prior year-end balance was for calculating his required minimum distributions (RMDs). He would then take his cumulative IRA RMD from IRA A only.
On Aug. 7, 2013 Peter’s bank escheated IRA B to Peter’s State, withholding a portion of the distribution for federal income tax purposes. In late 2014 — most likely more than a year after IRA B had been escheated — Peter went to his bank to get his prior year-end balance for RMD purposes. It was only then did he learn that his IRA no longer existed and was now state property.
Not only had his IRA been taken from him, but he had a fully taxable distribution. To rectify these issues, Peter immediately began to reclaim the funds from his state. On Feb. 12, 2015, Peter received a check for the amount the state had taken, plus interest, thus fixing part of the problem. To resolve the outstanding tax issue, he then submitted a PLR request to the IRS asking them to allow him to return the funds to his IRA via a late 60-day rollover.
The IRS granted Peter’s request, based on the fact that he had been unaware of the IRA distribution.
Escheatment dates all the way back to feudal England, but over time it became the right of a government to claim abandoned and/or unclaimed property. You might think of this as a government-run financial asset lost and found.
Unfortunately, in recent years, many states have turned escheatment from a process intended to make sure abandoned and unclaimed property does not lay stagnant forever, to a process intended make up for budget gaps and shortfalls. To that end, many states have changed the laws governing their escheatment process to make it easier to classify funds as abandoned. This has been done in a variety of ways by states, including:
• Changing the definition of “abandoned”: For years, the typical definition of “abandoned” centered on whether mail sent to an account holder’s address of record was returned as undeliverable by the post office. However, many money-hungry states have changed this definition to be entirely, or in some cases, potentially, driven by inactivity. But what constitutes inactivity? That is something that must be addressed on a case-by-case basis, but in some cases even accounts set up to automatically reinvest dividends or have those dividends sent directly to a bank account may be deemed inactive if other actions are not taken within a specified period of time.
• Reducing the period of time an account must be inactive for it to be considered abandoned: Historically, most states had laws that called for property to be considered abandoned after a period of five years or more. However, over the last decade or so, states have been reducing that length of time. In many states, the threshold for abandonment is now down to just three years.
In reality, preventing escheatment should not take too much effort on the part of a client, especially if they are working with an adviser. A simple log-in to a password protected website or a vote of proxies may be enough to keep an account from being considered inactive in some cases. For clients’ accounts that are on autopilot for one reason or another, this might be a good item for advisers to add to the annual review. If an account has not been accessed during the past year, do a cursory log-in of the account to protect it from being considered abandoned.
In the event that property is escheated, a state will often liquidate the property and turn it into state funds. However, if a client has a valid claim to the property, there is generally a procedure they may follow to have their escheated funds returned.
Advisers should know their state law and regulations, including the definition of abandoned property and the steps for clients to follow should they need to reclaim escheated property. It’s generally best to make sure clients are receiving statements of some kind. Also, make sure that clients are accessing their accounts or otherwise taking steps that would deem their accounts active in order to avoid potential escheatment.