Take-Away: We all know how important it is to name a beneficiary of an IRA. If there is no designated beneficiary then the IRA custodial agreement will usually provide a default beneficiary. If the default beneficiary under the IRA custodial agreement is the decedent’s estate, the pay-out period in which to empty the IRA is narrowed to 5 years from the decedent’s death. There is one exception to this harsh rule, but there must first be an alignment in the stars (or facts.)

Background: We have covered, admittedly time and time again, the benefits of using a stretch inherited IRA for non-spousal beneficiaries. We have also repeatedly covered the importance of naming a spouse as the primary beneficiary of the decedent’s IRA (or qualified plan account), because the IRA can be rolled over by the survivor, and thus delay the taxable pay-outs from the rollover IRA until the survivor attains age 70 ½. But what happens if there is no named individual beneficiary of the decedent’s IRA? The normal rule is that the decedent’s IRA must be emptied within 5 years of the decedent’s death, which essentially bunches all that taxable income into a relatively short period of time and thus exposes that income to marginally higher income tax brackets.

IRS ‘Exception:’ Despite taxpayer antipathy towards the IRS over the years, sometimes it seems the IRS actually has a heart. For the last couple of decades  the IRS has constructed a ‘facts and circumstances’ exception to the normal rule through a series of private letter rulings when a decedent has failed to name his/her spouse as the beneficiary of the decedent’s IRA. Private letter rulings are not supposed to be cited as legal precedent [IRC 6110(k)(3)], but it should come as no surprise that often the private letter rulings provide helpful roadmaps on how to avoid some of the more onerous retirement distribution traps in the Tax Code and its Regulations. A long series of private letter rulings  permit a factual exception to the normal rule when there is no named beneficiary to a retirement account. That series was added to again in yet another private letter ruling when a decedent failed to name his wife as the beneficiary of his retirement account. Private Letter Ruling 201821008, released May 25, 2018.

PLR 201821008: The facts in this private letter ruling (PLR) were straightforward. Husband died owning an qualified plan account established under IRC 457(b) by a governmental employer. The participant had failed to name a beneficiary under his retirement account sponsored by his employer. The plan document provided that the default beneficiary if no beneficiary was named by the deceased participant would be the decedent’s estate. If we stopped right there, that would trigger the normal rule that the decedent’s retirement account would have to be emptied within 5 years of his death, since he died prior to reaching age 70 ½. But now come the alignment of the facts (or stars.) There were no other beneficiaries of the decedent’s estate other than his wife. His wife was named as personal representative of his estate, which gave her total control over all assets of the estate, including the retirement account in question. Once the distribution was received from the plan, the survivor promptly distributed the net amount of the account, plus an amount equal to the taxes that were withheld by the plan, into an IRA in her name, all within 60 days of the distribution from the plan. Based upon these facts, the IRS permitted the surviving spouse-sole beneficiary-personal representative of the estate to roll the retirement account balance into her own rollover IRA and continue the income tax deferral until she attains age 70 ½. [IRC 402(c)(9).] The IRS said:

In this case, Decedent’s estate is the beneficiary of his account in the Plan, and his account was paid by the Plan to the estate in a lump sum (net of taxes withheld on the distribution.) Taxpayer, Decedent’s surviving spouse, is the executor and sole beneficiary of Decedent’s estate, and promptly distributed the amount received from the Plan to herself. Taxpayer then deposited the amount distributed from the Plan (including both the net amount the estate received from the Plan and an amount equal to the taxes withheld on such distribution) into IRA X within 60 days of the date such amount was distributed from the Plan. Under these circumstances, Decedent’s account under the Plan may be treated as paid from the Plan to Decedent’s spouse for purposes of Section 402(c).”

Source of Legal Authority: The legal authority for the IRS’s willingness to look the other way in this setting and permit a surviving spouse to rollover a retirement plan distribution to the decedent’s estate is in the Preamble to its Final Regulations where it states that ‘a surviving spouse who actually receives a distribution from an IRA is permitted to roll that distribution over… even if the spouse is not the sole beneficiary… A rollover may be accomplished even if IRA assets pass through either a trust or an estate.” See also PLR 2004-06048. What is a bit peculiar [yes, I’m looking a gift-horse in the mouth] is that the IRS repeatedly states that retirement benefits may be rolled over by a surviving spouse only if those benefits pass to the spouse from the decedent,  and that the general rule that it follows is that retirement benefits that pass to the surviving spouse through a trust or an estate are not deemed to pass to the surviving spouse from the decedent. Yet in almost every PLR the IRS proceeds to distinguish its ‘general rule’ from ‘the facts of this particular case.’ In short, the IRS has a general rule that it almost never follows- all to promote the surviving spouse’s ability to make a timely rollover.

Partial Rollover Permitted: A spousal rollover will be allowed for the portion of an IRA or other retirement account that is made payable to the survivor through a trust, where the rest of the IRA was payable, through the same trust, to other beneficiaries. PLR 2004-49040.

Limitations: While this lenient approach is a helpful exception to the normal rule that prevents rollovers when the decedent’s estate is the default beneficiary, it does come with a couple of limitations where the facts or the terms of the trust may prevent the required alignment of facts.

  • Survivor’s Rights Limited By Standard: If the surviving spouse is entitled under the trust terms only to income necessary for the survivor’s health, support, or maintenance, then a rollover will be denied because the survivor is not the sole payee of the decedent’s IRA that is payable to the trust. PLR 2006-18030.
  • Third-Party Discretion: If the surviving spouse’s receipt of retirement benefits depends upon the discretion of a third party, then a spousal rollover will not be allowed. However, if the surviving spouse herself is the trustee of the trust to which the IRA is made payable, and she exercises her discretion to allocate and pay the retirement benefits to herself, then a rollover will be allowed. PLR 2009-34046.
  • Funding Formulae: One interesting PLR was where the decedent’s IRA could apparently have been allocated to either a marital subtrust where the survivor possessed the right to withdraw all of its assets, or a credit shelter subtrust where the survivor was only the lifetime beneficiary. The surviving spouse acted as co-trustee of the trust with a professional trustee. The IRS permitted a rollover, but only for that portion of the IRA that exceeded $620,000 which was the maximum amount that could have been allocated to the credit shelter subtrust under the trust’s marital deduction trust allocation formula, despite the fact that no portion of the IRA was actually allocated to the credit shelter subtrust. PLR 2003-14029; PLR 1999-18065.
  • Debts and Expenses: One topic that the IRS seems to conveniently ignore in most of its PLRs (to the survivor’s benefit!) it the requirement of most wills, trusts or probate laws that require debts, probate court fees, administrative expenses, and taxes as a priority, before other assets are distributed from the decedent’s estate. Presumably the potential liabilities that these expenses pose could be viewed as a limit on the surviving spouse’s ability to take the retirement benefits paid to the estate without any restriction. Most PLRs’ simply ignore this possible restriction on the surviving spouse’s access to the retirement benefits, or in the handful of PLRs that do acknowledge the priority of these claims they simply took the taxpayer’s word that these expenses were paid out of ‘other assets of the estate.’

Conclusion: The ‘general rule’ is that if retirement benefits are made payable to the decedent’s estate, usually as the default beneficiary, there will be no rollover with its income tax deferral. That ‘general rule’ will not apply however in cases where: (i) the surviving spouse acts as the sole trustee of the decedent’s trust, or the sole personal representative of the decedent’s estate; (ii) if the survivor possesses  the sole authority and discretion in that fiduciary capacity to pay the retirement assets to themselves; and (iii) the survivor rolls all of the retirement account assets into a rollover IRA within 60 days of receipt, including any taxes that were withheld by the plan sponsor. PLR 2009-34046. This fact scenario or alignment of the stars can be created through timely qualified disclaimers of other named beneficiaries to the estate or trust, and/or a declination to serve as fiduciary by other third parties. All of that must be accomplished with a sense of urgency due to the need to move the retirement assets within 60 days of their receipt via a rollover.