IRA Valuation of Bad Investment for RMD

[Locust]

The situation is a bad investment in an IRA, a pyramid scheme that got shut down. The investment is frozen while the authorities try to figure things out, and it is probably valued at $0, but the custodian won't formally revalue - plus no payments can be made.

My assumption is that the custodian is responsible for valuing the IRA for purposes of calculating the required minimum distributions. Is this correct? (If not the custodian, who?) I suspect that the custodian just accepted whatever value was placed upon it by the investment company, and now it just wants to avoid the situation completely.

Do the IRS reporting rules now require a custodian to report the amount of minimum distributions due? Or the amount not distributed?

Is there a way to file with the IRS to indicate that no payment can be made from the IRA? Maybe file a Form 5330 with an explanation?

[Ron Snyder]

More tales of tax-sheltered losses, presumably in a Roth IRA where it can do some real harm.

The taxpayer is responsible for making the correct required minimum distribution. He/she should be prepared to show where the amounts come from. RMDs need not be made from assets which have no value. However, the balance of his/her IRA and qualified plan assets are still subject to the RMD requirement.

[John G]

Leasons for the average investor:

1. Don't deligate your "due diligence" to anyone else. Many bad idea could be avoided if investors just read the risk factors section carefully. If your accountant advises against the idea - think twice. If your buddies are not interested... maybe you too should look elsewhere.

2. Don't invest in anything you don't understand.

3. Don't fall for a supposed fabulous performance record. First, you don't need to hit a home run with every swing... getting to first via single, bunt or walk will probably get you to your long term goals. While there are ways to get double digit returns via careful investing, promises of more than 14% annual returns are generally BS. There is a radio ad on a number of talk shows that suggests you can earn $4,500 a MONTH! on a 25 to 45K investment. My math says that that is over 100% annaul. Complete bull, its a fair tale. If it was that easy, I sure wouldn't be talking about my "goose" to the general public.... I would want all the golden eggs. Billy Milller at Legg Mason is one of the great stock pickers (beating the S&P500 many years in a row), but is only a few percentage points above the long term average in stocks.

4. And finally, you can't lose 100% if you are diversified across many kinds of investments. Even in a stock market crash, everything does not always go south at the same time. A blend portfolio of stocks, bonds, and mutual funds is unlikely to drop more than 30% in a crash (although that is clearly still ugly).

[Locust]

John G - Wow. That was an impressively long response, but there was no attempt to even answer my question?! Do you know the answer, or have an opinion on it, but just got too carried away to give it? Locust

[Kirk Maldonado]

Locust:

Did you check to see if the applicable regulations address this issue? (I honestly don't know whether they do or don't.)

[Guest mjb]

L: if you review the custodial agreement you will discover that the custodian does not have any responsibility for valuing the asset in the IRA and relies on the asset for this info. I am not sure of the situation. Are you saying the clients only asset in the IRA is frozen and no distrbutions can be made from the IRA?

[Guest P A Weick]

RMD normally is calculated based on the last day of the prior year's market value of the account. That value must be placed on Form 5498 by the custodian. I always thought that the custodian had the duty to value the assets because it had to file the 5498. We try to shift the duty by contract to the customer where they buy assets that are not valued on a system we subscribe to, but I have never been sure how effective that will be if push came to shove.

[Locust]

mjb - Where does it say that the custodian has no responsibility? In the IRA regs? Or is this a contractual matter between the custodian and the IRA holder?

The situation is that the only asset in the IRA is an asset that can't be easily valued (may have no value) and can't be liquidated, and the custodian won't give a value and reports it at book value.

Kirk - I looked at the regulations for IRAs, particularly the requirements for being a custodian, but am not that familiar with them, and didn't see anything on first review. Also I thought that there was now some sort of reporting requirement for custodians on required distributions - there was talk of it at one time - but I don't remember any more.

To be honest, I was hoping someone else might have looked at the issue and could give me some direction.

It would seem to me that someone must have the responsibility for valuing the assets in an IRA for purposes of required minimum distributions - my guess was that it was generally the custodian because they are sort of like a trustee, and because otherwise you'd have to rely upon either the person who controls the investment or the holder of the IRA to value the assets, and both of those persons have conflicts. If it is up to the IRA holder to establish the value, it would be simple enough just to value it at $0 and that would be that. Maybe that is the way it will go - it will be up to the IRS to challenge the IRS holder's valuation, but I'd like to have some authority for this approach.

Thanks (and excuse me John G for being snippy.)

[Guest mjb]

look in the custodial agreement. Custodian does not want to be responsible for valuing odd assets b/c it would be required to pay for annual valuation. Custodian will only give value reported to it . I thought the value of the assets as of 12/31 must be provided to custodian by Jan 15th.

[Kirk Maldonado]

Locust:

My guess is that the answer (if one exists) would be in the regulations regarding required minimum distributions, not in the IRA regulations.

[John G]

My field of expertise more involves investment choice, stocks, funds, real estate (an I am loathed to bring it up again), and the risks/performance of different investment choices. I thought you got your direct answer before I posted. I added my post because I think your client's experience would be instructive to investors who might be tempted to buy things they did not understand or take unwise risks because they did not investigate the investment/company before acting. There are often over 100 general readers for each thread, although perhaps only a few are directly involved in the same circumstances.

All that said, I do have some experience with custodians and year end asset valuation. For 99% of the folks who read this thread (but not your client) this is a non-issue as the custodian simply uses market value (often the closing price) at year end for stocks, bonds, and mutual funds (funds must do the same with the individual portfolio components).

BUT... perhaps less than 1% of the IRA/Roth accounts include something that may not have an easy market price at year end. One year, I held a few thousand shares of stock in a company that planned to be listed on the NASDAQ but had not yet traded. Before I could purchase these shares (long story, but I had priority rights) I had to sign a special custodial form that said the custodian did not approve or disapprove of the investment, that I was to rely upon my tax adviser, and I might be held liable to paying for an independent assessment of the valuation of the investment at year end... each year at year end. I have seen this treatment a number of times, special custodial rules regarding unusual investment.

So... my questions to you are: What was the connection for this investment - it sure doesn't sound like a common stock company openly traded on an exchange? You referred to this as some kind of pyramid or Ponzi scheme.... how did that ever get by the typical investment exclusions most custodians impose. If this was not a typical stock/bond/option investment, did the custodian raise questions or seek a signed release before allowing the transaction? In my example, the custodian could have forced me to hire a consultant to pin down a valuation. Fortunately, I was able to convince the custodian that an alternative would suffice.

Although you have framed your posts in terms of custodian responsibilities and tax payer RMD obligations, there are some other issues that I think are worth discussing for the benefit of general readers.