You Inherit an Annuity…Should You Rely On Advice From A Broker?
Many times our clients are beneficiaries of a loved one’s annuity. They then go to their broker to discuss distribution options. Most brokers will advise their clients to discuss with their attorney or tax advisor which type of distribution to take. Suppose, however, the broker advises them to take a lump sum distribution and the client is taxed on income which could have been deferred if another option was selected.
Annuities and the taxation of distributions from annuities, a complicated issue, is governed by the Internal Revenue Code. A beneficiary has many options depending on the annuity contract. A recent Federal District Court case, Berkenfeld v. Lenet, arising out of Baltimore City, discusses what happens when the beneficiary picks a wrong option based on the advice of a broker.
A decedent, Claire, owned 2 annuities and named 3 beneficiaries. After Claire’s death, they selected a lump sum distribution which accelerated income tax. They sued their broker, Lenet, and Morgan Stanley, the firm Lenet worked for.
The defendants, Morgan Stanley and Lenet, moved for summary judgment and claimed that no reasonable trier of fact could find in the beneficiaries’ favor and, if they did find in the beneficiaries’ favor, the beneficiaires were guilty of contributory negligence.
Each beneficiary selected a lump sum distribution and also elected to NOT have any federal income tax withheld. Apparently Lenet incorrectly responded in an email that, if the monies would have been in an IRA then the beneficiaries could have deferred the income over 5 years, but since the annuities were owned by Claire, personally, the beneficiaries could NOT defer income over 5 years.
The beneficiaries claimed that Lenet’s advice was actionable and his lump sum advice was an opinion of Morgan Stanley. The beneficiaries never contacted the annuity insurance companies for advice. The form, which all beneficiaries signed, making the election to take a lump sum distribution, expressly stated ALL available distributions, such as a distribution over a term of years.
The court stated… “viewing the evidence most favoraby to the beneficiaries , the broker owed them a duty as their financial advisor”. Further, Lenet knew that the beneficiaries would rely on his advice which triggered a duty of care to exercise the skill and knowledge normally possessed by members of his profession. Like the beneficiaries, Lenet would have known the options if he had read the distribution options in the forms.
The court also found causation in that it was foreseeable that the beneficiaries would rely on the advice of their trusted financial adviser, the result of which was greater tax liability than taxes with other distribution options.
While the court found a duty, causation and damages in the negligence of the broker, the court also found that the beneficiaries contributed to their damages by not consulting with outside advisors, not reading the options provided in the form they signed and never consulting with the insurance companies. Under Maryland law, contributory negligence by the plaintiffs is a complete bar to recovery. Thus, summary judgement was entered for the defendants.
ADVICE: The consequences of this case should resonate with all advisors. Do not give advice if you are not sure. This author always asks “what does the statute state”. Many times we THINK we know the answer but until we actually research and confirm the law, the answer may be incorrect.
Also READ the document you are signing. A wrong distribution election can create adverse income tax consequences. Generally, distributions from an annuity or retirement plan taken over a period of years rather than a lump sum, do not avoid income tax but defers the income tax. The income tax bite will be less if less income is reported each year especially if you are in a lower tax bracket.
WORD OF THE WEEK: Contributory negligence is a failure to observe ordinary care for one’s own safety. Under the circumstances, contributory negligence is doing something that an ordinarily prudent person would not do or the failure to do something that a ordinarily prudent person would do.
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