IRS OKs Spousal Rollover. . . with a Twist | Ed Slott and Company, LLC

IRS OKs Spousal Rollover. . . with a Twist

By Sarah Brenner, JD
IRA Analyst
Follow Us on Twitter: @theslottreport

In recent Private Letter Ruling (PLR 201706004) the IRS allowed a widow to do a spousal rollover, but with an interesting twist that also ruled the five-year rule applied because the IRA had no designated beneficiary.

Widow’s Story

The story begins after the death of her husband, and the widow had a very unpleasant surprise. She was not named as the beneficiary of his IRA. Instead, he named a trust on his beneficiary designation form. To make matters worse, no evidence that this trust existed could be found anywhere. The custodian did not have a copy of the trust in its file. The widow looked through the IRA owner’s records and could not find any evidence that a trust existed. The IRA owner’s will made no reference to any trust. Instead, the will left the IRA owner’s entire estate to his widow.

The widow wanted to do a spousal rollover. In other words, she wanted to move her deceased husband’s IRA into her own IRA.  However, the custodian would not cooperate and release the IRA funds to her because the nonexistent trust was listed as the beneficiary on the beneficiary designation form. The custodian said that it would only release the IRA funds to the widow if she went to state probate court and got a court order modifying the IRA beneficiary form.

The widow asked the IRS for a PLR allowing her to do a spousal rollover, conditional on a state probate court approving the changing of beneficiary designation on the IRA from the trust to herself.

IRS Rules the Widow May Rollover But is Not a Designated Beneficiary

The IRS granted the widow’s request and allowed the spousal rollover. The widow was permitted to do the spousal rollover because the state court order would make her the beneficiary of the IRA and she is a surviving spouse.

However, the IRS only went so far. Not every beneficiary makes the cut to be a designated beneficiary. This was the fate of the widow in this PLR. The IRS said that while the state court could make the widow the beneficiary of the IRA, it could not make her a “designated beneficiary.” Why not? Because a designated beneficiary cannot be named by a court after the death of an IRA owner.

The Five-Year Rule

When an IRA owner dies before their required beginning date (April 1 of the year following the year they reach age 70 ½), there are two possible options for the beneficiary. If the beneficiary is a designated beneficiary, the beneficiary can take distributions from the inherited IRA over their single life expectancy. This allows for the distributions to be stretched for maximum tax benefit. Generally, a designated beneficiary must be a living, breathing person named on the beneficiary designation form by the IRA owner.

If there is no designated beneficiary, the IRA must be distributed using the five-year rule. The five-year rule means the IRA must be emptied by the end of the fifth year after the account owner’s death.

In this PLR, the IRS said that because there was no designated beneficiary on the account and the IRA owner died before he was required to begin RMDs, the five-year rule applied. However, the five-year rule applying did not necessarily mean bad news for the widow when it came to her request to do spousal rollover. According to the IRS, under the five-year rule, any amounts payable from the IRA to the widow in years 1 - 4 following the year in which her husband died would not be RMDs and would be eligible for rollover by her, provided the rollover would be otherwise valid.

Review Your IRA Beneficiary Designation Form

This PLR is yet another reminder of the importance of beneficiary forms. Here the IRA owner named a nonexistent trust as his IRA beneficiary. This resulted in his widow having to go to both state court and to the IRS for relief. That costs both time and money. Don’t let this happen to you! Check your IRA beneficiary designations forms regularly and update them as necessary.

If there are problems with a beneficiary designation form don’t expect a court to be able to solve them all. Decisions from courts may bring limited relief for federal tax purposes. In this case, while a state court was able to name the spouse as the IRA beneficiary enabling the custodian to release the funds to her, the state court could not make her a “designated beneficiary” in the eyes of the IRS. Although the limited relief worked out for this widow, you may not be so lucky!


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