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When Beneficiaries Don't Like the Plan

Use the right method, not the wrong method, to fix or change an IRA beneficiary designation after the participant's death.  

Natalie Choate, 03/08/2013

Question: A mother died, leaving her $400,000 house equally to her son and daughter, but only the son was named as beneficiary on the mother's $400,000 IRA. The children don't know whether the mother intended this unequal treatment, but they want to equalize their inheritances. The son proposes to assign half of the inherited IRA to the daughter to accomplish this result. Would that work, or would that be treated as a taxable distribution of the account? 

Answer: Assigning an inherited IRA to another person would cause the assigned portion (or possibly the entire account) to lose its status as an IRA and be deemed distributed. Furthermore, under our Tax Code, "doing the right thing," as the son proposes to do, is not regarded as a benign benevolence--it triggers a gift tax! The son's $200,000 transfer to the daughter would be deemed a taxable gift. 

Between income taxes and gift taxes, this would be a costly move. Let's review other options and see if there is another way to accomplish the children's goal with less drastic tax consequences. 

Reformation
It would be worth investigating to determine whether the mother really intended to leave the IRA only to her son or whether she intended to leave it equally, but was thwarted by perhaps someone drafting the beneficiary designation form incorrectly. Perhaps the mother believed that the form she signed left the account equally and did not realize that it named only one of the children. This type of mistake can happen easily, for example, when the account is being moved from one IRA provider to another, especially if it happened at a time when the mother was sick, traveling, or otherwise preoccupied. If there is strong evidence of such a "scrivener's error" (mistake by the professional who drafted the beneficiary designation form), the state probate court should agree to "reform" (rewrite) the beneficiary-designation form to say what it was supposed to say.  

A valid state-court-ordered reformation would probably convince the IRS that the IRA really belonged equally to the two children. But reformation is probably a long shot here. It's hard to get the professionals to admit they made an error, and court proceedings are expensive and time-consuming.

Disclaimer
When it appears that the documents were correct and were validly signed, and the mother knew exactly what she was doing, but the beneficiaries just don't like the outcome, consider a disclaimer. A beneficiary cannot be forced to accept an inheritance. Check who is the contingent beneficiary of the IRA because that is who would inherit any portion of the IRA that the son disclaims. If the daughter is the contingent beneficiary, then a disclaimer is the best option: The son accepts only half of the IRA and disclaims the other half, and the disclaimed half passes to the daughter. 

A qualified disclaimer would not be treated as a gift from the son to the daughter, nor would it trigger income tax on the IRA. The daughter would take over half the IRA just as if she had been named as 50% beneficiary in the first place. There would be no negative income or gift tax consequences; the IRA would stay in existence. 

However, if the daughter is not the contingent beneficiary of the account, a disclaimer would not be such an easy way out and might even be impossible. For example, if the son's children are the contingent beneficiaries, there is no way to get the disclaimed half interest over to the daughter unless the son's children also disclaim. And if they are minors, that might require appointment of a legal guardian who in turn probably would not agree to a disclaimer on their behalf. 

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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