Take-Away: Spousal rollovers were not changed by the SECURE Act. Naming a spouse as the decedent’s designated beneficiary is still the most tax-efficient manner in which to transmit a retirement account on the decedent-spouse’s death to his or her survivor, among several different options. While naming a spouse is the most tax effective manner to transmit a retirement account, an accumulation see-through trust will probably no longer work as planned if the surviving spouse is named as its beneficiary.

Background: The SECURE Act made fundamental changes to retirement plan distributions that impact a surviving spouse who inherits the deceased spouse’s retirement accounts. Those changes include increasing the required beginning date (RBD) from age 70 ½ to age 72 and casting a surviving spouse (for simplicity referred to as the survivor) into the category as an eligible designated beneficiary. These changes, while permitting the tax deferred accumulation of wealth by the survivor, also have created confusion on the ‘best’ way to distribute a retirement account to a surviving spouse. While a survivor has far more options for distributions than a non-spouse designated beneficiary, along with those options comes some confusion.

Note, too, that the Act did not change the penalty imposed on the failure to take a required minimum distribution (RMD) from a retirement account, or inherited retirement account, which remains at 50% of the amount that should have been withdrawn. [IRC 72(t)(1).] The magnitude of that penalty makes an understanding of the various distribution options available to the survivor imperative.

Quick Review: ERISA and the Tax Code have special rules for qualified retirement plan benefits, IRAs, and spouses. Qualified retirement plan (QRP) account balances are often treated differently than an IRA where the survivor may be named as the designated beneficiary.

  • Joint and Survivor Annuity: Perhaps the biggest difference is that with a qualified retirement plan (QRP) the participant cannot name another as the beneficiary of their account without their spouse’s consent. This federal law preempts any rules to the contrary. Accordingly, when a participant terminates employment and wishes to roll their qualified plan account balance into an IRA, they must obtain the informed consent  in the form of a written waiver from their spouse. [IRC 417(a)(2).] There is no federal preemption for IRAs. Accordingly, the deceased spouse-owner of the IRA can name whoever they want as their beneficiary, unlike with the QRP. [IRC 401(a)(11) and 417.]
  • Conflict of Interest?: (An aside: I wonder how many advisors take the time to tell the spouse of the plan participant, that when they sign their waiver, thus permitting the participant to roll their qualified plan account balance over to an IRA, that they are forfeiting their ‘right’ to a portion of those fund, or if they raise a red flag that the beneficiary designation with regard to the IRA can be changed at any time and without any notice to the spouse by the IRA owner? There have been plenty of surviving spouses who learned the ‘hard way’ that their deceased spouse disinherited them by silently changing the beneficiary of their IRA and removing the spouse as the sole beneficiary, which they would have been entitled to had the funds stayed in the spouse’s 401(k) account.)
  • Community Property: ERISA preempts all other laws with regard to qualified plans.  This means that community property principles do not apply to the beneficiaries of qualified retirement plans.  Boggs v. Boggs, 520 U.S. 833 (1997.) However, community property principles continue to apply to IRAs, but the income taxation of an IRA’s distributions will ignore the community spouse’s interest in the IRA. [IRC 408 (g).]

Rollover Distribution: For a surviving spouse, the best income tax consequence usually occurs with a rollover to a new IRA for the survivor if they are named as the sole designated beneficiary of the decedent’s IRA. A surviving spouse is the only person who can roll over a distribution from an inherited IRA or QRP account into a new IRA that treats the survivor as the new account owner. [IC 402(c)(9) and IRC 408(d)(3)(C)ii(ii)(ll).]

  • RMDs: As an eligible designated beneficiary, the survivor will continue to take RMDs using his/her life expectancy for distributions. This is the same, even if the survivor is disabled or chronically ill.
  • Favorable Distribution Table: When taking distributions using the survivor’s life expectancy, the survivor will be able to use the Uniform Lifetime Table that presumes the survivor has a beneficiary who is ten years younger than the survivor. The ability to use this Table reduces the amount of the taxable RMD that the survivor must take.
  • Caution: If the survivor is under age 59 ½, and he/she may need access to the rollover IRA for their support, the survivor will be exposed to the 10% penalty for an early distribution. The workaround this trap is for the survivor to leave sufficient assets in the  deceased spouse’s ‘inherited IRA’ to draw upon until age 59 1/2 (when he/she can then rollover the amount to the rollover IRA. The 10% early distribution penalty does not apply to an inherited IRA. In Sens v Commissioner, Tax Court Memo, 2010-146 (2010), the widow was named as the beneficiary of her husband’s $800,000 IRA. The widow rolled those funds to her own IRA. She then took a $60,000 distribution from that IRA to pay bills. The widow had to pay a tax and 10% penalty on the $60,000 distribution.
  • Survivor as Designated Beneficiary: As noted, a surviving spouse is the only person who can roll over a distribution from an inherited IRA or qualified retirement plan account (QRP) into a new IRA that treats the surviving spouse as the new account owner. [IRC 402 (c)(9) and IRC 408(d)(3)(c)(ii)(11).] If the survivor does not elect to make a rollover, he/she will continue to be eligible to take a distribution from the spouse’s retirement account based upon his/her remaining life expectancy. (See below)
  • Spousal Rule: This rollover option is available to the survivor either before or after the spouse’s required beginning date (RBD). This has caused some confusion because the SECURE Act changed the RBD from 70 ½ to 72 years. Unique to survivors is the time when the first RMD must be taken. An RMD by a survivor must commence on the later of: (i) December 31 of the year after the spouse dies; or (ii) the date when the spouse would have attained age 70 ½, which is now changed to age 72, the attained age to which the spouse’s lifetime RBD was tied. [IRC 401(a)(9)(b)(iv).] The confusion lies in whether a survivor who is receiving RMDs but his/her spouse was not age 70 ½ at death can stop receiving RMDs until the spouse would have attained age 72. That is probably an unrealistic interpretation of Congress’ intent to extend the RMD date of the spouse (not the survivor) to age 72. If the survivor dies before taking an RMD, the spousal rule will apply to the survivor’s successors, i.e. the individuals who the survivor names as beneficiaries of the rollover retirement account, which means that the designated beneficiary (by the survivor) becomes the relevant designated beneficiary of the spouse’s retirement account for purposes of determining the distribution period that follows the survivor’s death. [IRC 401(a)(9)(B)(iv)(11) Q&A 4(B).)]
  • Designated Beneficiaries: If the survivor elects to rollover the retirement assets to their own IRA, then they can name their own designated beneficiaries. This is also probably the biggest drawback to naming the spouse as the sole beneficiary of the decedent’s IRA, since the decedent is unable to control who the survivor will name as the designated beneficiaries of the new IRA, which can pose a problem in second marriages with children from the first marriages.
  • Disclaimers: Recall that one of the planning strategies after the SECURE Act is the ‘divide and conquer’ approach to RMDs. If the survivor rolls the spouse’s entire retirement account into their own IRA upon the survivor’s death, his/her designated beneficiaries, if not an eligible designated beneficiary, e.g. disabled or chronically ill, will be subject to the SECURE Act’s required ten-year distribution obligation. If the survivor disclaims a portion of the spouse’s retirement account, the disclaimed portion will pass to the spouse’s contingent designated beneficiaries, assumed to be the couple’s children. The children would then face the ten-year distribution obligation imposed by the SECURE Act on the disclaimed amount. When the survivor subsequently dies, if there is any amount left in the rollover retirement account, the children would then start a second ten-year distribution period after the survivor’s death. The effect is to spread the taxable distribution of some of the spouse’s retirement assets over a period of up to 20 years, thus avoiding the bunching of taxable income into a shorter period of time. [Observation: While this makes a lot of sense to minimize the income taxes imposed on a retirement plan distribution, the likelihood of the survivor actually electing to disclaim a portion of the spouse’s retirement account is slim, because of the fear of outliving their income needs.]
  • Creditors: By making the spouse’s IRA the survivor’s IRA with a rollover, the IRA will be treated as a new IRA owned by the survivor. It will be protected from creditor claims of the survivor by virtue of Michigan statute.

Inherited IRA: The survivor could alternatively, leave the retirement assets in the deceased spouse’s retirement account, treating it as an inherited IRA. Since the SECURE Act treats the survivor as an eligible designated beneficiary, the survivor is able to continue to use his/her remaining life expectancy to calculate their RMD for the year from the inherited IRA.

  • Distributions: Subject to the spousal rule, the survivor must take his/her first RMD by December 31 of the year following the spouse’s death, in contrast to a rollover, which would perhaps permit a delay in taking a  taxable if the survivor was younger than age 72. As noted, though, there would be no 10% penalty imposed on any distributions from the inherited IRA if distributions were taken from the inherited IRA prior to age 59 1/2.
  • Election: The survivor can elect to treat the spouse’s IRA as their own which has the effect of a rollover. However, the survivor’s election to treat the account as a rollover cannot be done with an inherited qualified retirement (QRP0 plan account where the survivor is named as the designated beneficiary. The election to treat the inherited IRA as a rollover is usually when the survivor fails to timely take an RMD from the inherited IRA.
  • Spousal Rule:  The spousal rule, described above, also applies to an inherited IRA by the survivor. The survivor does not have to take any RMD’s from the inherited IRA until the spouse would have attained age 72. [IRC 401(a)(9)(B)(iv)(1).]
  • RMDs: If the survivor establishes an inherited IRA, the survivor can still use the Uniform Lifetime Table, rather than the Single Lifetime Table, to determine the payout period for the inherited IRA [unlike the other designated individual beneficiaries who used to have to use the Single Lifetime Table, but who now face the SECURE Act’s required ten-year distribution requirement.] The survivor recalculates his/her remaining life expectancy each year when calculating their RMD for the year, rather than just subtracting one from the prior year’s life expectancy. [Reg. 1.401(a)(9)-5 Q&A -4(b) and Q&A 7(c)(3).]
  • Beneficiaries: If the survivor elects to treat the spouse’s IRA as an inherited IRA, then the survivor will not select the beneficiaries, as the IRA will continue to be treated as the spouse’s IRA.
  • Creditors: An inherited IRA is not protected from creditors under Michigan’s exemption statute. Nor is an inherited IRA protected if the survivor ever has to file for bankruptcy.

Conduit Trust: Since the survivor is now treated under the SECURE Act as an eligible designated beneficiary, it is more likely that if a trust is contemplated for the surviving spouse due to concerns about managing investments, spendthrift tendencies or a desire to assure that children or others will receive the balance of the retirement account on the survivor’s death, it will be a conduit trust. The survivor will be able to use his/her life expectancy to take RMDs. In addition, the survivor will recalculate his/her life expectancy annually, as opposed to merely subtracting one from the previous year’s life expectancy (which non-spousal beneficiaries must do.) The result is that there will probably be some remaining assets held in the IRA on the survivor’s death for the remainder beneficiaries of the conduit trust. [Reg. 1.401(a)(9)-9, Table A.] Thus, a conduit trust will provide creditor protection to the survivor, and can assure that possibly some assets will remain after the survivor’s death, but distributions from the IRA paid to the trust must be immediately paid out to the survivor.

Accumulation Trust: An accumulation trust will probably no longer qualify for using the survivor’s life expectancy distribution payout, despite being classified as an eligible designated beneficiary,  unless the survivor is disabled or chronically ill. The see-through trust rules still require that every beneficiary of the accumulation trust be counted (contrary to a conduit trust where the remainder beneficiaries can effectively be ignored.) As a result, an accumulation trust will have remainder beneficiaries who are not eligible designated beneficiaries, which will force the accumulation trust to use the ten-year distribution rule, unless the Final Regulations yet-to-be published tell us something different. t SECURE Act permits separate shares to be created under an accumulation trust for a disable or chronically ill designated individual beneficiary, (effectively permitting all other trust beneficiaries to be ignored) but that special separate share rule does not extend to a surviving spouse, who is also an eligible designated beneficiary, which is why all beneficiaries of the survivor’s accumulation trust must be ‘counted’ and why that trust would be required to empty the spouse’s IRA payable to it in ten years. Add to that the high tax rates imposed on trusts that accumulate income and it is a good explanation why an accumulation see-through trust probably will not be a tax effective means to deal with the spouse’s retirement assets on death.

QTIP Trust: A QTIP trust that is an accumulation trust, and not a conduit trust, will be subject to the ten-year distribution rule. The trust will be subject to heavy income taxation in that ten-year period, but the funds will remain accumulating for the benefit of the remainder beneficiaries. If the trust is a conduit trust, the trustee is forced to distribute all RMDs to the survivor. This type of trust poses tax challenges because the annual amount that must be distributed from the spouse’s IRA to the QTIP Trust will always be greater than the RMD that would have been required if the survivor had rolled over the assets to his/her own IRA, caused by the Revised Principal and Income Act requires the trust to treat retirement plan distributions to it; some of the taxable distribution to the trust  is classified as principal, thus remaining in the trust subject to the trust’s much higher income tax rates than the survivor’s marginal tax rate.

Woops- The Spouse Was Not Named As Beneficiary: A not-so-common problem is when the spouse dies without naming the survivor as the designated beneficiary of an IRA or qualified retirement account. Some relief can be obtained, but only by filing for a private letter ruling, which costs $10,000. The survivor can rollover the  deceased’s spouse’s retirement assets that are payable to an estate or trust, but only if the survivor is the sole beneficiary. For example, the survivor can roll over their deceased spouse’s IRA when the account is payable to:

  • Trust: PLR 201632015 (May 10, 2016) authorized a rollover when the husband’s IRA was payable to the wife’s revocable trust. PLR  201430029 (April 30, 2014) permitted a rollover by the spouse of a Roth IRA that was payable to a marital trust.
  • Estate+ Pour Over Will: A rollover was permitted when the deceased spouse’s IRA was payable to the probate estate, but there was a pour-over Will that distributed the estate’s assets to a trust for the survivor. PLR 201736018 (July 9, 2017)
  • Estate: The deceased spouse’s estate was the ‘default’ beneficiary of his IRA. The survivor was the sole residuary beneficiary of the  spouse’s estate. A rollover was permitted by the survivor. PLR  201445031 (August 11, 2014.)

Conclusion: There are several choices to consider with a retirement account when its owner is married. Every situation is different, so only broad generalities can be used. With that caveat, the most tax efficient approach is simply to name the spouse as the sole designated individual beneficiary. With that approach, taxes can be deferred as long as possible, while also protecting the retirement account assets from creditor claims. However, there has to be a lot of confidence that the survivor will name as his/her beneficiaries of his/her new IRA someone the spouse would want to receive what was left in the account on the survivor’s death. Probably the next best approach is for the survivor to elect to treat the spouse’s IRA as an inherited IRA, where pretty much the same tax benefits can be obtained but without as much creditor protection- the survivor will make this decision, though, not the spouse who owns the account. If a trust is warranted, probably a conduit trust would make the most sense from a tax-savings perspective as the trust can use the survivor’s life expectancy to take RMDs and all RMDs must be distributed to the survivor, thus exposing the taxable distributions to the survivor’s presumed lower income tax rates . An accumulation trust probably no longer makes sense with the survivor as its beneficiary, unless the survivor is disabled or chronically ill which is the only time the survivor’s life expectancy can be used to calculate RMDs from such a trust.