IRA Beneficiary Designation Defeated

IRA Beneficiary Designation Defeated – PLR 200327059

In a recent Private Letter Ruling ltr.200327059, the beneficiary designations did not permit the “Look-Through” provision once the surviving spouse disclaimed a portion of the deceased spouse’s IRA.

In this instance, the surviving spouse was the primary beneficiary.  The deceased spouse’s residuary estate was the beneficiary after the surviving spouse.  The surviving spouse wished to disclaim a portion of the IRA, and in doing so, sent the IRA assets to the residuary estate.  The look-through trust was the beneficiary of the Residuary Trust.  The IRS, however, had different thoughts.  They determined the estate (not the trust) was the beneficiary of the disclaimed portion of the IRA.  The income tax result was extremely painful.  The IRS stated that the IRA must be distributed to the trust over a period that can be no longer than five (5) years after the descendant’s death.  Due to trust income rules, much of the taxable distribution will have to be incurred by the trust.  Trusts, unfortunately, reach the highest income tax bracket at $9,350.00 (in 2003).

The use of a “Disclaimer Trust” is often recommended to provide a post mortem adjustment to the beneficiaries of qualified retirements plans or IRAs.  It is typical for a married participant or account owner to name his or her surviving spouse as the primary beneficiary of his retirement plan.  Typically, a participant will also have created a living trust or a trust created under the participant’s will to be the successor or contingent beneficiary.  The idea being that this trust would generally be designed to be free of estate taxes through the use of the deceased participant’s unified credit against estate taxes (currently, the credit exempts $1,000,000 from tax but will increase to $1,500,000 in 2004).  The surviving spouse is, in many instances, the income beneficiary for the life of the Unified Credit Trust.  Retirement plan regulations permit a trust to be the designated beneficiary of the plan or account with a “look-through” provision, which allows mandatory taxable distributions to be spread over the lifetime of the oldest beneficiary of the trust (Treas.Reg.Sec 1.401(a)(9)-4).  If the surviving spouse is the primary beneficiary and disclaims all or a portion of the plan, this would cause the benefit to be paid to a disclaimer trust in order to take advantage of the unified credit.  However, as evidenced by private letter ruling (Ltr. 200327059), if this is not done correctly the entire attempt to spread out the income taxation will be defeated.

How could this plan have been improved?  The trust should have been named as the successor or contingent beneficiary.  Most experts believe the beneficiary designation along with disclaimer provisions should be incorporated directly into the IRA or plan document.