There are two key categories of beneficiaries—primary and contingent. It is important to designate a primary beneficiary for your IRA. And it is almost equally as important to designate a contingent beneficiary, because death can be the catalyst for an override of one’s designated primary beneficiary.
Generally, any primary beneficiary of an IRA (who survives its owner) inherits the IRA balance that remains after the IRA owner’s death. A contingent beneficiary would step into the role of primary beneficiary if the designated primary beneficiary does not survive the IRA owner. A contingent beneficiary would also inherit any amount ‘properly disclaimed’ by the primary beneficiary or beneficiaries.
Therefore, naming a contingent beneficiary prepares for contingencies in cases of some “what ifs” that may happen with your primary beneficiary.
In private letter ruling (PLR) 201901005, the IRA owner designated a qualified Trust as the primary beneficiary of his IRA, but failed to designate a contingent beneficiary. Though the PLR was favorable, designating a contingent beneficiary would have avoided the expense of getting the PLR—which include the IRS’s fee of $10,000 and fees paid for any professional assistance—and the nuisance of having to engage in resolving the issue.
Facts of the PLR
For ease of flow, we are assuming that the IRA owner’s name is Blake and the surviving spouse’s name is Morgan.
Blake designated a qualified Trust as the sole primary beneficiary of his IRA. He did not designate a contingent beneficiary.
Blake, now deceased, was survived by his two children and two grandchildren.
The Trustee (of the Trust), the children and grandchildren all properly disclaimed any interest in the IRA to which they might have been entitled. The disclaimers resulted in Blake’s estate being the beneficiary of the IRA, and Morgan being the sole beneficiary of his estate. According to the PLR request, the disclaimers resulted in Morgan being entitled to the IRA as beneficiary of Blake’s estate, under State law.
What was requested
Morgan wanted to distribute the IRA to herself and roll over the distribution into an IRA in her own name. To that end, the following was requested under the PLR:
- That Morgan would be treated as having inherited the IRA directly from Blake, and not through Blake’s estate or Trust.
- That Morgan is eligible to roll over the distribution from the inherited IRA to one or more IRAs established and maintained in her own name, provided that the rollover occurs no later than the 60th day following the day the amount is distributed.
- That Morgan, as a result of the rollover, would not be required to include the distribution amount in her income.
The IRS approved all three requests.
IRS considerations
The following are some factors that the IRS took into consideration:
The IRS determined that Morgan was— technically—a spouse beneficiary
According to the IRS—in this case, although the Trust was designated as the beneficiary of the IRA, the disclaimers resulted in Morgan being entitled to the IRA as the beneficiary of Blake’s estate. And, since she was Blake’s surviving spouse, she was eligible to roll over the amount to her own IRA or other eligible retirement account.
My comment
If you have a client with a similar scenario, you might be wondering if your client can rely on this PLR as guidance. The answer is “No.” Under IRS§6110(k)(3), a PLR is not permitted to be used or cited as precedent. Therefore, an IRA custodian might not consider this PLR as basis for permitting such a rollover.
However, when one completes a 60-day rollover, one is not bound to disclose the source of the rollover to the IRA custodian. Usually, one simply attaches a rollover-contribution form to the check, certifying that the amount is eligible to be rolled over. The responsibility for ensuring that the amount is in fact eligible to be rolled over would rest with the IRA owner.
Nevertheless, one should consult with an attorney as to whether the fact pattern in this PLR is identical to one’s case, and whether the attorney agrees with the IRS’s interpretation of the applicable statutes. The attorney should be able to determine whether one should get one’s own PLR, or be eligible to roll over the amount based on the applicable authoritative sources cited by the IRS in the PLR.
Rollovers are excludable from income
The Tax Code provides that distribution amounts that are rolled over within 60 days of receipt are excluded from income, providing the amount is in fact eligible to be rolled over. Amounts that are not eligible for rollover include any required minimum distributions (RMD), and rollovers that would break the one-per-12-month-period, IRA-to-IRA rollover rule. Therefore, any amount that Morgan properly rolls over (i.e., rolls over within the 60-day deadline, and meeting all other rollover rules), would be excluded from income.
Of course, this is not a one-size-fits-all solution. And care must be taken to ensure that the provisions of the tax code are accurately interpreted. To that end, other factors, including the following, must be considered.
Be careful—this is a spouse-only solution
This solution is available only to a spouse beneficiary for the following reasons:
- Any party who inherits an IRA must keep undistributed amounts in a Beneficiary IRA. An exception applies only to a spouse beneficiary, who is permitted to keep those assets in her “own” IRA.
- A distribution made from an inherited IRA may not be rolled over, unless the distributee is a spouse beneficiary. And,
- A 60-day rollover contribution cannot be to a Beneficiary IRA.
If you are working with a nonspouse who becomes the beneficiary under such a scenario (as in PLR 201901005), then a possible solution would be to request a beneficiary reformation through a State court, which—if approved—would allow a transfer (not a rollover) to the Beneficiary IRA. In such cases, there must not be any distribution of the inherited amount that is intended to remain in the Beneficiary IRA—since, as noted above, a rollover of such amounts is not permitted by nonspouse beneficiaries.
Note: A nonspouse beneficiary would be subject to the same distribution rules that apply to the estate, even if the court approved transferring the assets to a Beneficiary IRA for the nonspouse beneficiary.
Be careful with disclaimers
The disclaimer approach taken in this PLR worked because it helped to produce the intended results. But it might not work in other cases. If you are working on a case that requires a disclaimer, your process should include the following:
- Making sure that the disclaimer is qualified. A disclaimer is qualified if it meets the requirements as stipulated under IRC § 2518. You might need the assistance of an attorney, tax professional, or IRA expert who understands these requirements, to assist with making the determination.
- Ensuring that the IRA custodian’s operational procedures are followed. Find out from the IRA custodian what they will accept for disclaimers. Some will accept instructions on a napkin as long as it is clear and signed by an authorized party. Others want documentation from a court. Waiting until the last minute could result in your client missing the 9-month deadline for submitting the disclaimer. And,
- Confirm who becomes the beneficiary as a result of the disclaimer. When a primary beneficiary disclaims an IRA, the contingent beneficiary inherits the disclaimed amount. If the contingent beneficiary disclaims the amount, then the default provisions under the IRA agreement applies. Default beneficiaries can include surviving spouse, surviving parents, surviving children, and estate of the decedent.
All parties who would become beneficiaries as a result of the disclaimer should be included in any related discussions, to determine whether they agree to provide any required authorization.
Avoiding the issue is best
I have often been told that a contingent beneficiary is unnecessary when the primary beneficiary is a Trust or nonperson, as they cannot die. But, as is evidenced by this PLR, there could be scenarios under which a Trust is deemed to no longer be the beneficiary because of a disclaimer.
In addition, there have been numerous cases in which Trusts designated as beneficiaries have been found to be nonexistent. That is also possible with a charity.
The best approach is to ensure that this complication is avoided, by designating both primary and contingent beneficiaries.
In some cases it might be helpful to have an estate planning attorney create a customized beneficiary form that provides for multiple levels of contingencies. Before doing so, check with the IRA custodian to determine whether they would accept and abide by the customized beneficiary designation.