Cross Collateralization IRA Agreements: Do You Have One?

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

Many IRA custodians are using cross collateralization language in the account opening agreements used in their financial services companies. What the agreement contains is language stating that if you or any of your accounts owe money to the financial service company, which you do not pay, then the company can take the amount owed out of any of the accounts that you have with them. This language is there for the sole purpose of protecting the financial service company from deadbeats.

In most cases, this language will not create any problems for the customers of these financial services companies. If I have a money market account and a margin trading account with XYZ Company and I have a loss in the margin trading account, XYZ company has the right to take the amount of the loss from my money market account and pay off the loss in my margin account.

However, if one of my accounts is an IRA, I cannot have any self-dealing with my IRA or pledge those assets as collateral. I cannot pay off a debt in my margin trading account with funds from my IRA. The reverse is also true. I cannot pay off a debt in my IRA with funds from my margin trading account. Either of those actions creates a prohibited transaction in my IRA. The prohibited transaction would result in a deemed distribution of the entire account balance in my IRA. It would all be taxable in one year.

How did all this happen? The powers that be at these companies interpreted a prohibited transaction exemption issued by the Department of Labor (DOL) incorrectly. Now millions of IRAs could potentially be destroyed.

Once IRS became aware of this problem, they issued temporary relief for IRA owners. They said that as long as there were no transfers of funds between IRAs and other accounts, that there would not be a prohibited transaction in the IRA.

The DOL is working on a permanent solution, but it is not the one that the financial services companies wanted. They are not getting a permanent exemption. Instead, what DOL has proposed is a six-month period for these companies to correct their IRA agreements. The cross collateralization language must be amended to reflect that IRA accounts cannot be used in any cross collateralization transactions.

IRA account owners and financial advisors need to be aware of these agreements. If you find that your account is covered by one of these agreements, you need to make sure that the financial services company makes the necessary corrections. The beginning date of the correction period has not yet been set but it is never too early to put your IRA custodian on notice that you are aware of this problem and that you expect a timely resolution of the problem. After all, you stand to lose your entire IRA.