Aside from a complete lack of control over investment decisions, significant drawbacks to RMAs include a lack of access to the assets in the RMA and a reduction or elimination of the discount in the event of a withdrawal prior to the end of the holding period (resulting in a potentially larger tax bill). These drawbacks—despite the unease the Strangi case has instilled in those currently relying on family limited partnerships—have challenged financial planners attempting to persuade their clients of the RMA’s value. Randy Fox, a certified financial planner at Wealth Strategies Counselors in Naperville, Ill., believes that RMAs are nevertheless overtaking family limited partnerships in popularity for two reasons: "First, the IRS’s recent attacks on partnerships. And second, RMAs are easier to set up and simpler to understand."

"[RMAs] have gotten much more attention over the last several months because of the Strangi case," notes David Handler, a partner in the Trusts and Estates Practice Group of Kirkland & Ellis, largely credited with creating the RMA strategy. "We’ve received many calls from bankers."
What is in an RMA?

Clients establish an RMA through a bank or trust company, which hires an investment manager or series of investment managers to invest and oversee the account. These are usually publicly traded securities, which are then under the full control and discretion of the bank or trust company. Indeed, the RMA’s covenants usually stipulate that the owner relegate control for a certain period of time and have no say in how the assets are managed. The client can suggest managers, but the bank or trust must choose, monitor, hire and fire them. The institution also determines the asset allocation. As with a blind trust, those who open RMAs must have profound confidence in the competence of their financial institution.

Trusts and banks that sell RMAs endeavor to position them as investments, rather than as estate-planning products, to keep them as far removed as possible from IRS scrutiny. Fox and others emphasize the investment benefits of a long-term buy-and-hold strategy, citing the famous Ibbotson Associates historical data on stock performance that shows that long-term investors beat those who jump in and out of the market. They also note that managers will lower their fees if they receive assurance the assets will be locked in for years. Yet, while this may be true, the real advantage of an RMA remains its value as a tax shelter.

"It’s extremely well acknowledged and customary since the 1960s that the tax imposition on a security that’s impacted by liquidity and reduced control [decreases because of] the valuation discount," says Larry Levine, who values RMAs as director of corporate financial services for American Express in Chicago. "It’s really that simple."

The classic example used to illustrate the discount is the case of a person who owns 100 shares of General Motors stock. If he can sell it today, it is worth the market price. But if he cannot sell it for a year, it is worth less, since it is less liquid: It cannot be easily converted into cash, and the owner runs the risk that the market for GM stock will fall before he can sell. The tax authorities recognize this and allow owners to discount assets more and more as the lock-up period grows.

For an estate, discounts are critical. Take the case of a grandmother with $50 million who wants to gift or transfer $40 million to her children and grandchildren. "Using an RMA, that $40 million all of a sudden becomes $24 million, because of the valuation discount," says Scott Hamilton, an estate planner with Strategic Planning Concepts in Chicago.

The size of the discount varies with the estate plan and the individual circumstances of the owner. "It’s proven that the longer the duration, the higher the discount," says Levine. Under five years, the discount is marginal, according to Hamilton. "There is no hard and fast rule. We would say no less than five years. Certainly there is a limit on the other end, too; from 10 years on, there isn’t a much bigger discount," he says.

To increase the discount, some estate planners have taken to stacking RMAs within a family limited partnership. Here, the general partner (the owner of the estate) assigns 99 percent of the shareholding in the limited partnership to others, keeping 1 percent for herself. Because of the lack of control, an automatic discount to the value of assets used to fund the LP—say 35 percent—would be granted. If those assets were to be placed in an RMA or series of RMAs within the limited partnership, the additional control restrictions could result in further discounting, possibly increasing the discount by another 25 percent. Fox and Hamilton wrote a paper analyzing a family limited partnership funded with $2.75 million in assets. Stacking an RMA within the partnership shaved nearly $500,000 more off the appraised value.

The Long Goodbye
The product is still quite new, and its backers admit it remains a tough sell. David Sennett, a private banker with Wachovia in Deerfield, Fla., is one of the few bankers to have put clients into an RMA (the firm has sold about a dozen overall). Sennett says his sales pitch is keyed to the investment advantages. "Under that strategy you would let us handle your assets for five years without your control. In return, we would use our investment management technology to gain any potential tax advantages and any potential discounts for your lack of control and access." It is at this juncture that Sennett says lots of potential RMA clients walk away. "We do get hammered on [lack of control]," he admits.

Even so, if the Strangi decision is upheld on appeal (the case is still before the courts), RMAs may look better and better. Citigroup Private Bank has an offering currently in the works, and Handler points out that trust companies are bringing themselves quickly up to speed on the product. Of course, some warn that RMAs may not hold up to IRS scrutiny. "There is no court case that says people are allowed to do them," notes James Brockardt at Wharton Valuation Associates in Princeton, N.J. However, even without an overt government blessing, Handler and others insist RMAs will be less subject to the IRS’s control strictures than are family limited partnerships. RMAs have binding agreements stipulating control and discretionary issues. "It’s truly arm’s length," Handler emphasizes. "Limited partnerships bear special scrutiny with the IRS because they are intrafamily arrangements subject to special scrutiny."

RMA backers also say they afford valuable flexibility in structuring an estate plan. "From a tax perspective, you can transfer at death or during life," Handler says. If you want to transfer assets to your children during your lifetime, you divide an RMA in two, he explains. Each account remains subject to the provisions of the original master account, so a child would have to wait out the term established when the account was opened before taking control of the assets. This has an additional benefit, Handler notes, "of kids not being able to go off and trade their account away."

RMA backers argue that they have other useful applications. These instruments can be used to extend the tax benefits of an individual retirement account, for example. IRAs defer taxes on investment gains until a person reaches 70.5 years of age and is forced to withdraw the assets. "If you have an IRA, and you take $8 million and put it in an RMA, then you shrink the value of the IRA," Fox observes. "Then the value of what you would have to take out would be reduced, and the transfer taxes would be reduced also."

With overall confidence in financial institutions in decline and even some top-shelf investment houses under investigation for mismanagement, handing over complete control of millions of dollars in liquid securities requires courage. Weighed against the risks that the investment manager will underperform—and that the IRS will set its sights on RMA valuation discounts—is the valuable tax shield these structures provide, which can substantially boost the overall performance of a portfolio. For long-term investors for whom avoidance of estate taxes outweighs the demand for current income, RMAs may fit the bill, despite their shortcomings.

From Your Side of the Table:
Questions to ask before establishing an RMA:

RMAs are long-term binding contracts. After consultation with legal, estate planning and financial planning consultants regarding whether an RMA is right for you, consider the following questions:

1. Is enough income generated by assets outside the RMA to ensure that I will be able to finance my lifestyle, factoring in an appropriate margin for emergencies?

2. Will my heirs be able to pay estate taxes with non-RMA funds? Will I outlive my RMA, and, if so, what are the consequences?

3. Do I trust the institution managing my RMA and its investment management judgment?

4. What are the penalties for early RMA withdrawals for my heirs and me?

You or your advisors should also conduct a due diligence review of your estate and financial plans and the institution managing the RMA before you sign a contract.

Illustration by Ken Orvidas