June 11, 2018

New IRS PLR Resolves Yet Another Failure to Designate a Beneficiary for a Retirement Account

By Denise Appleby, CISP, CRC, CRPS, CRSP, APA

Beneficiaries could be saddled with the high cost of account owners’ failure to name beneficiaries for their retirement accounts. This can be avoided by properly completing beneficiary designation forms, and making updates when necessary.

Recently issued private letter ruling (PLR) 201821008 is yet another case of a failure to properly designate a beneficiary of a retirement account. In this case, the IRS remedied the issue by approving the surviving spouse’s rollover of a Governmental 457(b) account to her own traditional IRA, even though the decedent’s estate was the beneficiary of the 457(b) account. The IRS considered the spouse’s rights and control over the estate, in responding to the PLR request.

Background

Before we discuss the facts of the PLR, let’s take a high-level look at the applicable rules and regulations.

Rollover Permissibility and Rules

Designated beneficiaries are permitted to roll over amounts they inherit under employer sponsored retirement plans* to IRAs, as long as the amounts are eligible for rollover (IRC § 402(c)(11). This option is not available to nondesignated beneficiaries.

*For this purpose, an employer sponsored retirement plan is a qualified retirement plan (pension, profit sharing, 401(k) etc.), a 403(b) plan, a thrift savings plan, and a governmental 457(b) plan.

Appleby Commentary

It is important here to understand the difference between a designated beneficiary and a nondesignated beneficiary. While both are ‘beneficiaries, only a designated beneficiary is permitted to roll over a distribution from an employer sponsored retirement plan.

A designated beneficiary is a person – such as a spouse or nonspouse, or a qualified trust as defined under Treas. Reg. 1.401(a)(9)-4, Q&A 5.

A nondesignated beneficiary is a nonperson, such as an estate, charity, or nonqualified trust.

Such rollovers must be completed within 60 days of receipt, unless an exception applies.

Tax Treatment

Generally, amounts that are not eligible for rollover- such as distributions to nondesignated beneficiaries- must be included in the income of the recipient beneficiary, for the year in which the distribution occurs.Whereas, amounts that are properly rolled over to a traditional IRA continue to be tax-deferred.

Amounts that are eligible to be rolled over and are paid to a beneficiary, is subject to a mandatory 20% federal tax withholding on taxable amounts. If the amount is not eligible for rollover, then withholding is optional, allowing the beneficiary to elect to withhold at least 10% for federal taxes.

Identifying the Beneficiary

The beneficiary of a retirement account is the person or entity named on the governing beneficiary form at the time of the participant’s death, providing that beneficiary survives the participant.

If there is no such (named) beneficiary, then the beneficiary is determined under the terms of the governing plan document.

Facts of the PLR

The following is a summary of the relevant facts as presented in PLR 201821008:

  • At the time of the participant’s death, there was no named beneficiary for his 457(b) account. As a result, the beneficiary was determined under the default terms of the 457(b) plan.
  • Under the default terms of the 457(b) plan, his estate was his beneficiary.
  • After his death, the plan distributed the balance of his account to his estate.
  • Federal income tax was withheld from the distribution amount.
  • His surviving spouse was the sole executor and sole beneficiary of his estate.
  • His spouse, in her role as executor and beneficiary of the estate, promptly distributed the amount from the estate to herself, and subsequently rolled over the amount to her IRA by the 60-day deadline. This included the amount that was withheld for income tax, which she made-up out of pocket.

The following rulings were requested:

  1. That the surviving spouse is treated as receiving the distribution directly from the plan, and not from the estate.
  2. That she is considered eligible to roll over the distribution to her own non-inherited IRA. And,
  3. As a result of the rollover, the distribution from the 457(b) plan would not be included in her income.

The IRS’s Ruling

The IRS approved all three ruling requests based on the facts and circumstances, on condition that the information and documentation submitted are subject to verification upon examination. The IRS noted that the ruling could be revoked if there are any misstatements or omission of facts that could change the outcome.

Appleby Commentary

This ruling does not come as a surprise. The IRS has traditionally allowed rollovers for surviving spouses, where the estate is the beneficiary, and the spouse is the sole executor and sole beneficiary of the estate. See PLRs 200644031 and 200637033.

Tax Filing

The IRS will be notified of both the distribution- which must be reported on IRS Form 1099-R and the rollover- which must be reported on Form 5498. Since these transactions are required to be reported on the affected parties’ tax returns, a copy of the PLR must be attached to such tax returns. The PLR helps to make the case of why the distribution is nontaxable.

For electronically filed tax returns, an attached statement that includes the date and control number of the letter ruling would suffice.

Costly Lesson and How to Avoid It

The cost to the beneficiary includes the IRS’sfee of $10,000 for handling the PLR request, plus any fees paid to professionals who aid with the process. These fees, and operational requirements that then become necessary, would have been avoided had the participant ensured that his spouse was named as the beneficiary for his 457(b) account.

As an advisor, you can help your clients by performing a beneficiary check-up for all their accounts, at least once per year and when there is a life-event that could affect the beneficiary designation. The check-up should include reviewing the governing plan document to determine whether the default provisions are consistent with your clients’ estate planning goals.

Reminder: A PLR may not be used or cited as precedent. IRC Section 6110(k)(3)

Helping financial/tax professionals help their clients avoid and correct mistakes with IRA transactions.

Written By

Retirement Dictionary Staff

Frequently Asked Questions Regarding

The second answer is correct. As his beneficiary, you are required to take his 2013 RMD from the IRA that you inherit from him. The amount must be reported under your tax identification number, as it should be included in your income. Generally, you are required to transfer the amount to your Inherited IRA to ensure proper tax reporting of the distribution. Bear in mind that even though he has died, the amount must be calculated as if he had lived to the end of the year.

No.  You cannot rollover or transfer an Inherited IRA to your own IRA, because you are a non-spouse beneficiary. A non-spouse beneficiary is defined as a beneficiary that is not the surviving spouse of the deceased IRA owner.  As a non-spouse beneficiary of an IRA owner who died before his required beginning date (RBD), you are required to have the amount moved to an inherited IRA.  An inherited IRA is one that is registered in the name of your uncle’s ( the decedent) and your names, using your social security number.  An example of a registration that satisfies the IRS requirements is: IRA FBO Jim P, Beneficiary of Tom S (Deceased)”. Any variation of this will work, as long as it is clear who is the beneficiary and who is the decedent.  Some financial institutions may shorten ‘beneficiary’ to read ‘bene’, ‘beneficiary of ‘to read ‘B/O’ and/or ‘deceased’ to read ‘decd’.

Depending on the financial institution’s operational requirements, you may need to move the assets to a new account number, or they may reregister the same account number used by your uncle. Any method will satisfy IRS requirements, as long as distributions are reported in your social security number.  If the assets are moved to a new account number, it should be done on a non-reportable basis, i.e. it should not be done as a distribution or contribution.

Your distribution options are as follows:

  • Distribute the assets over yourlife-expectancy.  Under the life expectancy method, you must take a required minimum distribution (RMD) amount each year. Your first RMD amount would be due by December 31 of this year (the year after your uncle died). You can withdraw more than the RMD amount- up to the entire balance – at anytime.
  • Distribute the assets under thefive-year rule. Under the five year rule, the entire balance must be distributed by December 31, of the 5th year, following the year your uncle died. Since he died in 2007, the assets must be fully distributed by December 31, 2012. Distributions before then are optional.

If you fail to withdraw your RMD amount by the deadline, you will owe the IRS an excess accumulation penalty of 50% of your RMD shortfall. For instance, if your RMD for the year is $10,000, and you withdraw only $2,000, you will owe the IRS an excess accumulation penalty of $4,000 ($8,000 x 50%).

Distributions from your inherited IRA cannot be rolled over; however, you can transfer amounts to another inherited IRA, providing the receiving inherited IRA is registered in both your’s and your uncle’s name.

It depends.

Bear in mind that the distribution options for beneficiaries of a traditional IRA depend on whether the IRA owner dies before the required beginning date (RBD).

Because Roth IRA owners are not subject to the required minimum distribution (RMD) rules, there is no RBD for Roth IRAs. Therefore, the distribution options for Roth IRAs are usually the same as those that apply to a Traditional IRA when the owner dies before the RBD. The IRA agreement must be consulted to be sure, as the custodian ultimately determines whether they want to offer both the five-year and the life-expectancy options.

Some IRA agreements limit a spouse beneficiary’s options to treating the Roth IRA as his/her own, instead of choosing to treat the account as an inherited Roth IRA.

For a high level summary of the options, see

 

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