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IRA Payable to an Estate: What to Do

Is there any way to "fix" the beneficiary designation?

Natalie Choate, 11/13/2009

Check out Natalie's downloadable special reports at her Web site. There are six reports, including The 194 Best & Worst Planning Ideas for Your Client's Retirement Benefits, Retirement Benefits and the Marital Deduction (Including Planning for the Noncitizen Spouse), Making Retirement Benefits Payable to Trusts, The Estate Administrator's Guide to Retirement Benefits, Charitable Giving with Retirement Benefits, and her newest, Roth-Ready for 2010! ($39.95). The price of each report includes three downloads, so you can get updated versions free as they are created.

Question: My father died in 2009, leaving a $42,000 IRA, of which $2,000 is aftertax money. There was a federal estate tax on his estate; the portion attributable to this IRA is $10,000. He had named my mother as beneficiary, but she predeceased him. There was no contingent beneficiary, so I assume that means the IRA is payable to his estate as default beneficiary. The estate is payable equally to his five children. He would have turned 75 on his 2009 birthday had he lived. The children are interested in deferring the income tax as long as possible. I know the estate cannot be a "designated beneficiary," so there cannot be a life expectancy payout to the estate. Is there a way to "fix" the beneficiary designation, so the children could be named directly (and therefore qualify for a life expectancy payout)? Or can the children at least get a payout over what was left of father's life expectancy? To do that do we have to keep the estate open?

Natalie: Here's what I recommend.

First, read the IRA document very carefully. Some IRA documents provide that the default beneficiaries are the decedent's issue. If your father's IRA happens to be with a firm that uses that approach, then the children ARE the "designated beneficiaries" of the account, even though they were not named by your father.

Assuming the IRA document does NOT say that, however, and instead says what is usually the case (namely that the estate is the default beneficiary), the next thing to look at is whether you could successfully persuade a state probate court to "reform" the beneficiary designation form to name the children directly as contingent beneficiaries. State laws typically permit post-death reformation of an instrument if there is strong evidence that there was a mistake in preparation of the form-your father intended to name the children, but due to someone else's mistake ("scrivener's error") that didn't happen. The IRS would probably accept the state court reformation under those circumstances. However, because of the small size of this IRA, it's unlikely that any tax savings would be large enough to justify the cost of a reformation proceeding.

Also, if there is no evidence that somebody made a "scrivener's error," and it just looks like what happened is that your father neglected his estate plan, then the IRS will probably not accept a "reformation" even if you can get a state court to order it.

Absent a valid reformation, assuming you are stuck with the estate as the beneficiary, the Applicable Distribution Period for the IRA is 12.4 years starting in 2010. That's based on the single life expectancy for a person age 75 in 2009 (13.4 years), minus one year. 
 

There are two ways to take advantage of this. One is for the estate to remain open for 12 more years, gradually withdrawing from the IRA, and passing out each year's required minimum distribution to the five children equally. The drawback of that approach is the high administrative cost of keeping the estate open, including probate court costs and tax-preparation fees.

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