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Choose the Right Cleanup Strategy!

Sweep the cobwebs off of your estate plan the right way.

Natalie Choate, 07/09/2010

Natalie Choate will be speaking at a location near you if you live in Kiowa Island, S.C. (7/24/10), National Harbor, Md. (7/28/10), Atlanta (7/29/10 and 9/30/10), Chicago (8/20/10), Dallas (9/2/10), Orlando, Fla. (Jan. 2011), Detroit (10/29/10), Philadelphia (7/23/10 and 11/12/10) or Harrisburg (12/7/10), Pa., Kansas City, Mo. (9/24/10), South Bend, Ind. (10/28/10), Jacksonville, Fla. (5/10/11), or Memphis, Tenn. (12/1/11). See all of Natalie's upcoming speaking events at www.ataxplan.com.

It often happens that a retirement plan participant dies with a less than ideal estate plan. He names no beneficiary for his retirement benefits, or she names the wrong beneficiary. The survivors are left trying to "clean up" the estate plan. Two useful cleanup approaches are reformation and disclaimer. Sadly, some families make things worse by choosing the wrong cleanup strategy.

Question: "Mother" was a widow. When she remarried, she signed a prenuptial agreement promising to leave her IRA to a marital deduction "QTIP" trust for the life benefit of Husband, with remainder to her three children from her first marriage. However, she didn't do what she had agreed to do; instead, she named her three children directly as beneficiaries of the IRA. The children realize they are not entitled to this money and propose to disclaim the IRA. The effect of the disclaimer would be that the IRA would pass to Mother's estate as default contingent beneficiary, and thence to the QTIP trust, which is residuary beneficiary under Mother's will. What do you think?

Natalie: If a decedent tried to do something, or thought she did something, or had agreed to do something, and that "something" did not end up getting done in the actual documents in effect on her death, the correct remedy is to reform the documents so they reflect what the decedent tried to do or thought she had done or was supposed to do. A disclaimer is usually not the right remedy in this situation.

One requirement of a "qualified disclaimer" is that the disclaimed property must pass either to the decedent's surviving spouse or to someone other than the person making the disclaimer. In your situation, the proposed disclaimer would violate this rule, because the three children are the remainder beneficiaries of the QTIP trust. The QTIP trust receives the money as a result of their disclaimer, so they are disclaiming the property right back to themselves (after Husband's death).

PLR 2008-46003 illustrates the result of such a disclaimer on the same facts as yours. As a nonqualified disclaimer, the children's well-intentioned action was treated as a taxable gift of the entire IRA value by the children to the QTIP trust; and there would be no marital deduction for the transfer to the QTIP trust because, as far as the IRS is concerned, the IRA went from the participant to the children to the QTIP, not directly from the participant to the QTIP.

Instead, consider going to state court seeking an order enforcing the prenuptial agreement and reforming the beneficiary designation to say what the prenuptial agreement said it should say. Even if the IRS does not recognize the reformation for purposes of determining the Applicable Distribution Period under the minimum distribution rules (see next question), it should be effective to shift the IRA and the income tax burden thereon to the trust.

Question: "Father" died, leaving his IRA to a QTIP trust for the life benefit of "Mother." The trust provides that Mother receives all income of the trust for life, but no principal. On Mother's death, she can appoint the trust principal to any issue of the couple and/or any charity. If she does not exercise this power, the trust property passes on her death immediately outright to the couple's children. As written the trust does not qualify as a "see-through trust" under the IRS' "minimum distribution trust rules" because of the potential appointment to charity (a non-individual beneficiary) at Mother's death. The trustee is planning to go to state court and get an order reforming the trust instrument so it provides that mother cannot appoint any retirement benefits (or proceeds thereof) to charity. Will that work?

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