Using the Disclaimer as an Estate Planning Tool | Ed Slott and Company, LLC

Using the Disclaimer as an Estate Planning Tool

By Jeremy Rodriguez, JD
IRA Analyst
Follow Us on Twitter: @theslottreport
If you’re like me, when you first read the qualified disclaimer rules, the phrase comes “must be nice” comes to mind. And while it’s true these rules are used more often by wealthier Americans, anyone can incorporate them into their estate planning as a tool to make last minute changes. In fact, disclaimers can be a valuable postmortem planning tool giving beneficiaries one last opportunity to divert a bequest to accomplish family goals, such as tax savings.

The Basics
A “qualified” disclaimer is an irrevocable refusal by a potential beneficiary to accept benefits given through a transfer of property. The disclaimer can be a complete or a partial disclaimer refusal of the bequest. If done correctly, the disclaiming individual will be treated as having predeceased the donor and the property will pass to the contingent beneficiary. Moreover, the transfer will not be considered a taxable gift. To have a qualified disclaimer, four conditions must be met:
  1. Writing: the refusal must be in writing.
  2. Timing: generally, the disclaimer must be made within nine (9) months after the date of death. However, if the disclaiming beneficiary is under age 21, the deadline is extended to nine (9) months after reaching age 21.
  3. No Acceptance: the disclaiming beneficiary must not have accepted any interest in the benefits.
  4. No Control: the disclaiming beneficiary cannot control to whom the property passes, and the property passes to someone other than the beneficiary or to the decedent’s spouse.

The IRS has held that a beneficiary can accept a decedent’s final Required Minimum Distribution (“RMD”) and still make a valid disclaimer. In other words, receiving the decedent’s final RMD does not mean the beneficiary accepted an interest in the IRA and is therefore prohibited from disclaiming the bequest. However, after receiving the RMD, the beneficiary cannot disclaim that amount. Similarly, the income attributable to that RMD also cannot be disclaimed. The income is determined under a formula that looks at the earnings/losses that have accumulated in the account between the IRA owner’s death and the date the disclaimer was issued.

There are three (3) ways to issue a disclaimer; a Full Disclaimer, a Pecuniary (or dollar figure) Disclaimer, and a Fractional Disclaimer. Obviously, the Full disclaimer applies to the entire account. If no RMD is due, then the entire IRA balance would transfer to the contingent beneficiary without an income calculation. On the other hand, if an RMD is due, an income calculation becomes necessary. Unlike the RMD, the income portion does not need to be distributed. Instead, it can be held in a separate account within the IRA for the original beneficiary. Going forward, the original beneficiary would have to draw RMDs from this amount (or cash out the subaccount).

For example, let’s say a beneficiary needed to take a deceased IRA owner’s final RMD of $10,000. Since this is the IRA owner’s RMD, it needs to be distributed to the original beneficiary before the end of year in which the IRA owner died (i.e., Dec. 31 of the year of death). The income on that RMD would be determined as of the date of the disclaimer. If that amount was $200, this sum would be segregated in a subaccount within the IRA for the original beneficiary. The rest of the account would pass to the contingent beneficiary.

The Pecuniary (or dollar figure) Disclaimer and Fractional Disclaimer methods also have income calculations. With the Pecuniary method, the income is determined on the amount disclaimed. On the other hand, the Fractional method applies the income calculation to the IRA balance on the date of the disclaimer.  

Final Thoughts
Disclaimers allow beneficiaries to transfer tax-free “gifts” to contingent beneficiaries when the circumstances make sense. Remember, the tax law treats a disclaiming beneficiary as having predeceased the IRA owner. That means the contingent beneficiary could either access the disclaimed IRA balance or stretch the distributions out over his or her life. If the contingent beneficiary were a young adult, they could use this amount as a jump start on life (i.e., college expenses, new car or home purchase, or expenses related to a new career). The assets would also have a longer period for investment growth.

Of course, to take advantage of this strategy, the IRA owner must name a contingent beneficiary! If no contingent beneficiary is named, the disclaimed gift will pass according to the IRA custodial document or retirement plan document. Therefore, every IRA owner should name a contingent beneficiary; not only in case the primary beneficiary predeceases him or her, but also to allow beneficiaries to make last minute changes to the estate plan that still fit within the IRA owner’s ultimate wishes.  Because of the complexities mentioned above, any beneficiary looking to issue a disclaimer should first seek the advice of a knowledgeable tax professional.


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