Estate Planning Update: Recent IRS Ruling Offers a Stark Reminder of the Benefits of Proper Estate Planning for Retirement Accounts
Despite ultimately finding in favor of a taxpayer surviving spouse, IRS Private Letter Ruling 2023-22-014 (the “PLR”) is chock-full of reasons to ensure proper planning is in place when it comes to IRAs.
In the PLR, released in early June, a deceased husband left a sizeable retirement account. The problem: he never named a beneficiary, causing the IRA to pass to his probate estate. In his will, the decedent named his wife as the executor and sole beneficiary, meaning the entire IRA would ultimately pass to the decedent’s wife by way of his probate estate. Generally, a retirement account passing to an estate or non-qualified trust must be fully withdrawn by the beneficiary through an inherited IRA within five years of the decedent’s death, and any distribution must be included in the beneficiary’s gross income in the year of the distribution.
A retirement account passing directly to a surviving spouse by beneficiary designation, on the other hand, may be rolled over to the surviving spouse’s own IRA and withdrawn through required minimum distributions over the spouse’s life expectancy. The difference can be decades of tax-free growth and significantly stretched income taxes.
In the case at hand, the decedent’s surviving spouse desired to receive her husband’s IRA as a spousal rollover and not as an inherited IRA through an estate. She requested a private letter ruling that she was permitted to roll the proceeds into her own IRA without including the distribution as gross income, and therefore allowing her to receive her husband’s IRA through required minimum distributions over her life expectancy.
The IRS noted in the PLR that IRAs passing through a third party at the owner’s death, such as an estate, before being distributed to a beneficiary are generally treated as passing to the beneficiary by the third party and not from the deceased, precluding a spouse from rolling the proceeds into her own IRA. However, in the PLR, the IRS found that because the surviving spouse was the executor and sole beneficiary, “no third party can prevent the surviving spouse from receiving the proceeds of the IRA and from rolling over the proceeds into the surviving spouse’s own IRA,” and therefore, the estate can be disregarded and the spouse can proceed as if she was the named beneficiary. As such, the decedent’s wife was not required to include the distribution as gross income or withdraw the IRA within five years, and she was permitted to roll it over to her own IRA and take required minimum distributions over her life expectancy (note that the spouse had stipulated that she would complete the rollover to her IRA within 60 days of the distribution from her husband’s IRA, as required).
Although the end result is taxpayer-friendly, the PLR represents a common situation that can be easily avoided. In this case, the lack of planning created years of uncertainty and frustration for the decedent’s wife, not to mention tens of thousands of dollars in legal and IRS fees.
Proper planning ensures an IRA passes directly to the intended beneficiary, and in the case of a surviving spouse, that he or she will reap the benefits afforded spouses under the SECURE Act and Internal Revenue Code. Further, a probate estate often subjects those assets to significant probate fees and risk of depletion by the decedent’s creditors, and if the decedent’s will names other beneficiaries, or if the surviving spouse is not named as the executor of the decedent’s estate, the complexity increases drastically and the taxpayer-friendly attributes all but disappear. The PLR is also a cautionary tale of estate planning through an estate and not a trust or beneficiary designations; still, in many cases, it is advisable to name the spouse first as the sole beneficiary and executor of an estate to protect against lapsing beneficiary designations and to keep all retirement planning options on the table, and then to name a trust as the contingent beneficiary.
If you’d like to discuss IRA best practices or other estate planning matters, or if I can ever be a resource to you or your clients, please contact me at 513.579.6488 or email@example.com.