For some time, prominent commentators have requested that the Internal Revenue Service publish official guidance to deal with this increasingly common scenario:1 A deceased spouse's IRA is payable to a trust in which the surviving spouse is the sole beneficiary or has an unrestricted right to withdraw trust assets. This spouse then seeks to move the IRA to an account in her name, so she can, among other things, withdraw the IRA over a longer life expectancy or designate her own beneficiary. But when she relates this desire to the IRA custodian or trustee (collectively known as the “IRA sponsor”), she often hears: “Not until you obtain a favorable private letter ruling from the IRS.”
Unfortunately, PLRs take time and are expensive.
Existing guidance leads to the perceived need for these PLRs. That's because the Internal Revenue Code expressly authorizes rollovers of a deceased spouse's IRA to the survivor's IRA.2 A Treasury regulation, Section 1.408-8, implementing the IRC's rollover provisions, allows the surviving spouse to make a spousal election to treat the deceased spouse's IRA as her own (without making an actual rollover).3
The sticking point lies in having a trust as the primary IRA beneficiary, because Section 1.408-8 precludes a spousal election through a trust even if the surviving spouse is the sole trust beneficiary or holds a power to withdraw trust assets.4
Caught in the middle, the IRA sponsor presses the PLR button to escape the dilemma. The IRS, for its part, has obliged many surviving spouses in this situation. It has issued numerous PLRs allowing surviving spouses to roll over IRAs initially payable to trusts.5
When granting these favorable PLRs, the IRS has relied on the preamble to the Treasury regulations.6 One portion of the preamble states that if the surviving spouse actually receives an IRA distribution (other than a required distribution), the surviving spouse may roll it over “regardless of whether or not the spouse is the sole beneficiary of the IRA owner.” The same treatment applies if the surviving spouse exercises a right to withdraw from the portion of the trust holding the right to IRA payments.7
Although the outcome is favorable, it comes at a price. The cost of a PLR exceeds $10,000, and that's not counting compensation paid to the preparer.8 And, of course, PLRs are limited to the taxpayers who requested them.9 So, each taxpayer facing this dilemma has to go through the same process.
Until the IRS provides official guidance to taxpayers on this issue, IRA sponsors could consider other solutions.
A solution that I propose relies completely on published authority and operates to preserve the spousal election when an IRA is payable to a trust in which the spouse is the sole beneficiary or has an unrestricted right to withdraw trust assets.10
This solution embraces the idea that the spouse's rights in the IRA mirror those in the trust named as beneficiary (sometimes referred to as “the beneficiary trust.”) The key concept is to view the IRA as a separate trust that constructively exists as a subtrust of the beneficiary trust. But this subtrust is unique, in that the IRS recognizes the IRA as an acceptable trust through which the spouse can make the spousal election.
By treating the IRA as a separate trust in which the surviving spouse is the sole beneficiary, this reconciles the current conflicting provisions in Treasury Regulations Section 1.408-8.
Special conditions embedded in the beneficiary designation form make the surviving spouse the direct beneficiary of the IRA as separate trust. This language satisfies the restrictions of Treas. Regs. Section 1.408-8. The surviving spouse would have a limited time in which to make the election to treat the deceased spouse's IRA as her own. If the spouse fails to make the election, the IRA loses its status as a separate trust. The IRA sponsor then distributes the IRA benefit to the beneficiary trust.
The concept of the IRA as separate trust finds support in the IRC. Section 408(a) states that an IRA “means a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries.” The IRS has extended the IRA as separate trust to the estate tax context. In Revenue Ruling 2006-26,11 the IRS treated a deceased owner's IRA as a separate trust rather than another asset of the trust named as beneficiary. To qualify for the estate tax marital deduction, the trust had to entitle the surviving spouse to all of the IRA's accounting income as if the IRA were a separate trust.
In the context of the spouse's rights to make the deceased spouse's IRA her own, this solution requires an election by September 30 of the year following the IRA owner's death, commonly known as the “beneficiary finalization date.”12 This is the date the Treasury regulations set for determining the designated beneficiary for anyone named as a beneficiary as of the IRA owner's date of death. A designated beneficiary may use a life expectancy to withdraw required minimum distributions (RMDs). Use of the beneficiary finalization date, for example, permits removal of non-designated beneficiaries to preserve a named designated beneficiary's life expectancy.
Conceptualizing an IRA as a separate trust changes the application but not the intent of the beneficiary finalization date. If the spouse makes the election, it removes the beneficiary trust as the IRA beneficiary. If the surviving spouse fails to make the election, the beneficiary trust becomes entitled to the IRA benefit. The surviving spouse may still have an entitlement to the IRA. But then she'd be forced to go the traditional “get a private letter ruling” route to exercise control over the IRA.
Language in the beneficiary trust would match the language of the beneficiary designation form. Nothing in the terms of the trust named as beneficiary would preclude treatment of the IRA as separate trust. Moreover, the terms of the trust to which the IRA is payable would make the surviving spouse the sole beneficiary eligible to receive distributions or give an unlimited right to withdraw trust assets.
The third and final element to this proposed solution deals with protecting the IRA sponsor. The IRA owner would certify in the beneficiary designation form that nothing in the trust to which the IRA is payable would prevent the surviving spouse from making the spousal election under Treas. Regs. Section 1.408-8. The trustee of the beneficiary trust would have no right to IRA distributions until the beneficiary finalization date.
The IRA sponsor, in turn, could rely on the certification to protect it in allowing the spousal election. In no event would the IRA sponsor have to read the terms of the beneficiary trust or ever interpret/determine whether the trust's terms were inconsistent with the beneficiary designation form. Finally, the beneficiary designation form would hold the IRA sponsor harmless for allowing the surviving spouse to make the election. This scenario assumes the IRS in official guidance would agree to this method to verify the surviving spouse's rights in the IRA.
Prescribing the spousal election within the beneficiary designation form has one additional benefit: It avoids the rollover process with its defined time frame for depositing the deceased IRA spouse's benefit into the surviving spouse's IRA.13 A respected commentator, Virginia F. Coleman, partner in the Boston office of Ropes & Gray, has stated she believes that the surviving spouse, according to Treas. Regs. Section 1.408-8, Q&A-7, may still need to make the spousal election following an actual rollover of the deceased spouse's IRA.14 Otherwise, the IRA remains in the deceased spouse's name.
The benefit of an election making the surviving spouse the owner rather than the beneficiary of the deceased spouse's IRA brings distinct advantages. The surviving spouse can name her own beneficiaries and withdraw RMDs over a longer life expectancy than as a beneficiary of the deceased spouse's IRA.
What if the surviving spouse fails to make the election prior to the beneficiary finalization date? Has the failure caused a gift?
The short answer is “No,” if the IRA benefit winds up payable to a trust whose terms mirror the surviving spouse's direct rights in the IRA as separate trust. Under both scenarios — the IRA as separate trust and the rollover through a trust — the surviving spouse holds the same economic benefit and has not relinquished dominion or control over the IRA.15
Equally important is whether a failure to make the spousal election results in a transfer of income in respect of a decedent (IRD). IRD, according to the Treasury regulations, are “amounts of gross income to which the decedent was entitled,” but due to death, are not includible as taxable income for the year of death or for a previous year.16 The IRD is taxable to the recipient. An IRA is IRD.17
If someone transfers IRD through a gift, it constitutes a disposition for income tax purposes. The transferor then realizes income upon the disposition.18
In the “IRA as separate trust” scenario, no transfer for IRD purposes should result from failure to make the spousal election. There will be no gift. If properly drafted, the beneficiary designation form would reflect the same rights in the IRA that the beneficiary trust vests in the surviving spouse. The failure to make the election should not cause the loss of the IRA's economic benefit passing through the beneficiary trust to the surviving spouse.
Perfecting the spousal rollover using the IRA as separate trust impacts estate planning before the owner's death. The planning has two components. First, it preserves the opportunity for the spouse to make the deceased spouse's IRA her own without a rollover and without having to pursue a PLR.
The second component is flexibility. The IRA owner may choose to make the estate plan flexible by giving the trustee discretion to allocate the IRA to one or more postmortem trusts. If the surviving spouse has the requisite rights in the trust to control the IRA benefit, the spousal election can apply with a properly worded beneficiary designation form.
For various reasons, the IRA owner may decide to give the trustee discretion to allocate the IRA benefit to a trust in which the surviving spouse has a restricted interest. For example, a surviving spouse may have sufficient assets of her own. The trustee then might allocate the IRA to a trust in which the surviving spouse has limited rights and forfeit a potential spousal election.
Alternatively, the IRA owner might be in a second marriage situation and want to leave the IRA benefit to children by his first marriage, yet still qualify the IRA and trust for the marital deduction. The trust might restrict the rights of the surviving spouse to mandatory payments of all of the IRA's accounting income. The spousal election would then be unavailable.
Hoping For Guidance
In a perfect world, IRA owners who want to designate their spouses as their primary beneficiary would do so directly in the beneficiary designation form. The Treasury regulations and IRC readily recognize the spousal election through a direct designation. Unfortunately, because IRA owners frequently name a trust and grant surviving spouses the right to receive distributions or withdraw trust assets, a spousal election in this context is problematic. The idea of an IRA as a separate trust may help many individuals caught in this process. The concept draws its rationale from both the code and the IRS' official pronouncements.
The estate planning community and IRA sponsors would welcome guidance from the IRS supporting this idea — or suggesting another solution.
— The author thanks Michael J. Jones of Monterey, Calif.'s Thompson Jones LLP for his insights into the issues discussed in this article.
— This article is for informational purposes only, and does not constitute a solicitation of any kind. Opinions expressed are those of the author and may differ from the opinions expressed by departments or other divisions or affiliates of Wells Fargo. Although information in this article is believed to be reliable, Wells Fargo and its affiliates do not warrant the accuracy or completeness and accept no liability for any direct or consequential losses arising from its use. Neither Wells Fargo nor any of its affiliates provides tax or legal advice. Clients should consult independent counsel/tax advisors in connection with matters covered in this article.
- Marcia Chadwick Holt, “Webcast Musings,” Trusts & Estates (September 2006) at p. 42; Michael J. Jones, “A Costly and Unnecessary Detour,” Trusts & Estates (May 2008) at p. 25.
- Internal Revenue Code Section 408(d)(3).
- Treasury Regulations Section 1.408-8, Q&A-5(a) (“In order to make this election the surviving spouse must be the sole beneficiary of the IRA and have an unlimited right to withdraw amounts from the IRA.”)
- Ibid. (“If a trust is named as beneficiary of the IRA, this requirement is not satisfied even if the spouse is the sole beneficiary of the trust.”)
- See Michael J. Jones, supra note 1 at p. 26.
- T.D. 8987, 67 F.R. 18988-19028, April 17, 2002.
- See Michael J. Jones, supra note 1 at pp. 26-27, citing the various rulings; Marcia Chadwick Holt, supra note 1 at p. 42, for discussion of Private Letter Ruling 200807025 in which the surviving spouse did not have sole authority to pay herself the IRA benefit through a trust. Nevertheless, the Internal Revenue Service allowed the rollover.
- See Michael J. Jones, supra note 1 at p. 25.
- IRC Section 6110(k)(3) (a PLR may not be cited as precedent).
- Another potential solution is the creation of an individual retirement trust (IRT). An IRT casts an IRA as a self-contained trust and typically offers a menu of potential beneficiary options. An extended discussion of the IRT is beyond the scope of this article.
- 2006-1 C.B. 939.
- The term “beneficiary finalization date” is not found in the applicable Treasury regulation, Treas. Regs. Section 1.401(a)(9)-4, Q&A-4(a), but comes from Natalie Choate's comprehensive treatment of IRAs and estate planning in Life and Death Planning for Retirement Benefits (6th ed. 2006), ATAXPLAN Publication, at p. 96.
- See IRC Section 408(d)(3)(A) (distributions received must be rolled over within 60 days of receipt).
- Virginia F. Coleman, “Special Distribution Options Available to the Surviving Spouse as Beneficiary of a Qualified Plan or IRA,” ALI-ABA Webcast Encore Presentation: Estate Planning with Qualified Plans and IRAs (November 2008) at p. 6.
- Treas. Regs. Section 25.2511-2.
- Treas. Regs. Section 1.691(a)-1(b).
- See Natalie Choate, supra note 12 at p. 121.
- Treas. Regs. Section 1.691(a)(4) (transfer of right to income in respect of a decedent).
David S. Sennett is a risk manager in the California Trust Center of Wells Fargo. He's based in Long Beach, Calif.