“Estate Bypass” - Spousal Rollover When the Estate is Beneficiary
By Andy Ives, CFP®, AIF®
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An estate can become the beneficiary of a person’s IRA in a couple of ways. First, the estate could be named outright as the beneficiary on the beneficiary form. This is not recommended. Why? One reason is that a non-designated beneficiary (like an estate), must follow certain restrictive payout rules. For example, if an IRA owner names his estate as beneficiary and then dies prior to his required beginning date (April 1 of the year after the year he turns 73), the estate is subject to the 5-year payout rule. There are no annual RMDs during this 5-year period, but the entire account must be depleted by the end of this compressed window. Had a living, breathing, non-eligible designated beneficiary been named, that person would have twice as long to empty the account (and spread the taxes due) using the 10-year rule.
Another way an estate can become the beneficiary of an IRA is if no beneficiary is named at all. If no beneficiary form is on file with the custodian, and if no form can be produced by the family, we are forced to look to the default beneficiary as dictated by the custodian. Oftentimes this is the estate. As such, an estate-owned inherited IRA is opened, and we follow the non-designated beneficiary payout rules. Any distributions from the estate-owned inherited IRA are paid into an estate account and are then distributed (and taxed) to the estate beneficiaries.
Recently, an advisor contacted me with just such a scenario. The beneficiary form slipped through the cracks on one of his client’s IRAs. Unfortunately, the client passed away before the oversight was identified. Even though all the client’s other accounts named his surviving spouse as primary beneficiary, this IRA was stuck using the custodian’s default beneficiary – his estate.
What to do? Is there any recourse that would allow the surviving spouse to simply do a spousal rollover of the IRA assets into her own name? All was not lost. I asked the advisor if the spouse was the sole beneficiary of the estate. If she was, there is historical precedent for allowing a spousal rollover. What historical precedent? Private letter rulings, or “PLRs.” PLRs are IRS decisions specific to a particular scenario. Technically, PLRs can only be relied upon by the person who requested the ruling. But if enough PLRs reach the same conclusion on similar situations, a trend is established. In fact, allowing a spousal rollover when the estate is named as the IRA beneficiary (and the spouse is the sole estate beneficiary) is one such PLR trend.
Each of the following PLRs permitted a spousal rollover when either a workplace retirement plan or an IRA named the estate as the beneficiary: PLR 201430020, PLR 201430027, PLR 201821008, PLR 201839005. In fact, another PLR - 200343030 - was the first ruling that allowed non-spouse beneficiaries to establish their own inherited IRAs when the estate was named. However, while inherited IRAs were permitted and the estate could be closed, the non-spouse beneficiaries were still bound by the payout rules applicable to the estate.
Be aware that these PLRs are not a “get-out-of-jail-free” card. The custodian must allow the transaction to take place, and there are no guarantees they will. (Anecdotally, I know of one custodian who has an internal process for such transactions, and they call it an “estate bypass.”) Of course, this whole estate-as-beneficiary, please-let-me-do-a-spousal-rollover mess can be avoided if you diligently check…and update…all beneficiary forms.
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