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Estate Transfers IRA to Beneficiary

The "stretch" or "life-expectancy-of-the-beneficiary" payout is available only to a "designated beneficiary."

Natalie Choate, 04/08/2011

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Do you have your own solutions/suggestions? Leave a comment at the end of the article!

Judging by the number of questions I get on this topic, this is one of the hottest issues out there. I've consolidated the most common questions into one typical scenario:

Question: "Yuri" died in 2010 at age 68 without having named a beneficiary for his IRA. Under the account documents for this particular IRA, the default beneficiary is Yuri's estate. He also left no will, so under the applicable intestacy laws, the estate passes half to Yuri's wife "Lara" and half to their daughter, "Tonya." The estate has no other assets. Lara, as administrator of the estate, has instructed the IRA provider to transfer Yuri's IRA in equal shares, via direct IRA-to-IRA transfer, half to Lara's own IRA and half to an "inherited IRA" payable to Tonya as beneficiary. The IRA provider refuses to do this unless an "inherited IRA" is opened in the name of the estate first. We are at an impasse. If the IRA provider insists on this condition, then the IRA will be subject to the "5-year rule." We want to instead have Lara do a spousal rollover of her half, and Tonya wants a life expectancy payout for her half. We also don't want to have to report the account as an estate asset for probate purposes. How can we resolve this dilemma?

Answer: On this one, the IRA provider is doing it right.

To back up a little bit, there is nothing wrong (in my opinion) with your goal of transferring the IRA out of the estate, intact, to the estate's two beneficiaries. Some IRA providers permit estates to do this, requiring only that the executor or administrator of the estate take control of the account and then give proper instructions for the transfer. Some IRA providers permit the transfer but have more substantial requirements--for example, the IRA provider might require an IRS ruling, legal opinion, and/or hold harmless agreements from the beneficiaries. And some IRA providers do not permit such transfers under any circumstances.

But whether or not the IRA provider permits the estate fiduciary to transfer the account out to the estate's beneficiaries, the IRA provider cannot deal with the fiduciary at all until the fiduciary has provided proper documentation to establish the fiduciary's right to give instructions with respect to this asset. Typically this means the fiduciary must (1) provide documentation of its right to deal with the account, such as a certificate of appointment from the Probate Court, and (2) sign the IRA provider's paperwork agreeing that the estate (as IRA beneficiary) is bound by the IRA provider's terms and conditions. Only once the IRA provider has this documentation can the provider begin taking orders from the estate fiduciary with respect to the deceased participant's IRA.
 
If the estate is going to transfer the asset out to the beneficiaries immediately, the IRA provider may or may not require the opening of an actual formal "inherited IRA account" in the name of the estate, before allowing that account to be closed as the IRA is transferred to the beneficiaries. If this step is required, the new "inherited IRA" account will be titled "Yuri IRA, payable to the estate of Yuri as beneficiary" or "Lara, administrator of the estate of Yuri, as beneficiary of Yuri." Some IRA providers might be willing to dispense with formally opening an account in the name of the estate as beneficiary, once the executor has provided evidence of its authority, written acceptance of the IRA provider's terms, and instructions for the transfer.

The transfer instructions would say in essence, "I, Lara, as administrator of the estate of your deceased IRA customer Yuri (see my certificate of appointment attached) hereby instruct you to divide the above account [i.e., Yuri's IRA] into two separate equal inherited IRAs, one titled 'Yuri, deceased, IRA, payable to Lara as successor beneficiary' and the other titled 'Yuri, deceased, IRA, payable to Tonya as beneficiary.'"

So the "good news" is that (one way or another) Lara can do these transfers. If the IRA provider she is dealing with won't allow the transfers, the account can be moved (still as an inherited IRA in the name of the estate as beneficiary) to a more cooperative IRA provider.

The bad news is that, unfortunately, Lara is misinformed about the effects of doing this transfer. Transferring the account to Lara and Tonya individually will not magically transform them into "designated beneficiaries" for minimum distribution purposes.

The "stretch" or "life-expectancy-of-the-beneficiary" payout is available only to a "designated beneficiary." A "designated beneficiary" means an individual or a qualifying "see-through trust." When Yuri died, there was no designated beneficiary on his IRA account. His estate was the default beneficiary, and (under the IRS' regulations) an estate cannot be a "designated beneficiary." Therefore the stretch or life expectancy payout method is not available for this IRA. Transferring the account out of the estate has absolutely no effect on the "applicable distribution period" for the account. It does not cause the transferees to become "designated beneficiaries" with respect to the account.

Yuri died before his required beginning date, with no designated beneficiary, meaning that the applicable distribution period for his IRA is the "5-year rule." All funds must be distributed out of his IRA no later than Dec. 31, 2015. As a result of the transfer, Tonya is now the successor beneficiary of "her half" of Yuri's IRA, but she is not entitled to use the life expectancy payout method.

The only bright spot here is that, although the IRS regulations never permit a life expectancy payout for benefits payable to or through an estate, the IRS applies more lenient standards when the issue is the spousal rollover rather than the life expectancy payout. Because Lara, the surviving spouse, was entitled to half the IRA through the estate as her intestate share, the IRS might well allow her to "roll over" her half into her own IRA, thus salvaging substantial income tax deferral.

I understand that families and their advisors can be very upset when they receive this answer, because it may mean they have to incur probate costs they hoped to avoid and the daughter does not get the life expectancy payout she hoped for. These bad results are caused by Yuri's failure to do proper estate planning, not by some evil intent on the part of the IRA provider.

Resources: The following sections of Natalie Choate's book Life and Death Planning for Retirement Benefits (7th ed. 2011) ($89.95 plus shipping, www.ataxplan.com) provide complete discussion and citations to authority for the points discussed in this answer:
 
See ¶ 1.5.02, "Road Map for determining post-death MRDs," for how to determine minimum required distributions (MRDs) after the death of the IRA owner; ¶ 1.5.03(E) covers MRDs for benefits payable to the participant's estate when the participant died before his required beginning date. See ¶ 1.5.06 for the "5-year rule."
See ¶ 6.1.05 regarding transferring retirement benefits, intact, out of a trust or estate.
See ¶ 3.2 regarding the "spousal rollover" generally, ¶ 3.2.09 for letter rulings allowing the spousal rollover of benefits "through" a trust or estate.

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Natalie Choate practices law in Boston, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is fast becoming the leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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