General Practice, Solo & Small Firm DivisionMagazine
Volume 17, Number 6
Estate and Financial Planning
A Recipe for Success: Ten Tips for Planning
the Distribution of Large IRAs
BY Richard S. Franklin
1. Be aware of the required beginning date. The interest of any owner in an IRA must be distributed in lump sum or must begin to be distributed ratably over the life expectancy of the owner on or before the required beginning date (RBD). The RBD for traditional IRAs is April 1 of the calendar year following the year in which the owner reaches age 701/2. Available distribution options depend on one or two applicable life expectancies (i.e., the owner and the designated beneficiary). The existence of a second relevant life expectancy depends on the nature of the beneficiary as of the RBD. Also, whether (and to whom) recalculation of life expectancy will apply is determined as of the RBD. Failure to analyze the overall objectives and make specific choices before the RBD will lock in the default election.
2. Plan for a spousal rollover. A spouse is a favored beneficiary under the minimum distribution rules. If the IRA plan document provides all of the options permitted by law, a spouse could postpone distributions to December 31 of the calendar year in which the owner would have reached age 701/2. The surviving spouse could also elect to treat the inherited IRA as his or her own IRA. By doing so, minimum distributions would not begin until the surviving spouse’s RBD. Even if the owner were beyond his or her RBD on his or her date of death, the surviving spouse may roll over the account and obtain a new payout period. No other beneficiary can take advantage of a rollover.
3. Recalculate one life expectancy. When planning for a married couple with sizable accounts, recalculating only the owner’s life expectancy and not recalculating the spouse’s life expectancy will generally be a good solution. Recalculating the owner’s life expectancy assures the continuation of payments until the owner’s death, which provides a hedge against the owner’s living beyond expected mortality. If the owner and the spouse both die before expected mortality (with the spouse dying first), the balance remaining at the owner’s death can be distributed over the predeceased spouse’s remaining fixed life expectancy, as initially determined. If the spouse survives, the spousal rollover (discussed above) is available.
4. Show your client the effect of the recalculation rules. It is critical to show a client what must be distributed both during his or her lifetime and at death. One option is to present the MRDs as percentages. By using percentages, a client can more easily recognize the significance of a percentage like 4.385965 than by seeing an expected return multiple of 22.8.
5. Plan for a client’s incapacity. Clients who come to discuss estate planning on retirement are often in their early to late 60s or even younger. It is not too early to document the distribution election plan that is to take effect on the RBD and provide the election information to the IRA custodian or trustee. If the client becomes incapacitated before his or her RBD, steps already will have been taken to select and document the appropriate election. Durable powers of attorney should authorize the attorney-in-fact to change the distribution election, investments, and account custodians, and to accelerate distributions.
6. Prepare custom beneficiary designations. Planners should prepare their own IRA beneficiary designations to specify the client’s primary and secondary beneficiaries. The beneficiary designation should indicate what happens in the event of a disclaimer or simultaneous death, as well as what happens on the death of a beneficiary who survives the owner but dies before the account is fully distributed. The beneficiary designation should usually provide that each beneficiary may change investments, custodians, or trustees and may accelerate distributions at any time.
7. Consider establishing separate accounts for children. A practitioner should consider establishing separate accounts for each child. Unless separate accounts are established, the child who has the shortest life expectancy is treated as the "designated beneficiary" for purposes of calculating the MRD. To enable each child to use his or her life expectancy to determine the payout period of his or her separate share, the safest approach is to establish separate IRA accounts for each of the children before the RBD (or, if earlier, the owner’s death).
8. Act quickly following an owner’s death. After an IRA owner’s death, counsel should review the controlling IRA trust agreement or custodial account agreement; the beneficiary designation in effect on the owner’s death; the beneficiary designation in effect on the owner’s RBD and at all times after the RBD, if the owner was beyond his or her RBD; and the distribution election in effect for the account. If the owner was beyond his or her RBD, counsel should ensure that the MRD for the year of the owner’s death is distributed before the close of the calendar year.
Many post-death options are time-sensitive. The timing of a spouse’s election to treat the account as his or her own should be carefully considered. This election to treat an IRA as the surviving spouse’s IRA, according to the proposed regulation, occurs when the spouse takes an action that is inconsistent with the account’s being the decedent spouse’s account, such as making a contribution or failing to take an MRD. If the spouse does not elect to treat the account as his or her own, the spouse may have to take annual distributions as a beneficiary or continue under the deceased spouse’s election. By defaulting to the rollover, the proposed regulations offer protection to the spouse who fails to take an MRD that would otherwise be required.
9. Keep IRAs inherited by a nonspouse in the name of the original owner. An IRA beneficiary must be able to identify the source of each IRA he or she holds. The IRA custodian or trustee must state the name of the beneficiary and the prior owner. This is necessary because the rules that apply in the case of an IRA held by a nonspouse beneficiary are different from the rules that apply to the original IRA owner. Also, different treatment may be required for IRAs received due to the deaths of different original IRA owners. An IRA received by a nonspouse beneficiary on the death of a given IRA owner must be kept separate from any IRA established by the nonspouse as an original owner, and also separate from any IRA received on the death of any other original IRA owner.
10. Be wary of the lack of guidance. There has been little official guidance from the government on the minimum distribution rules. Within this vacuum, significant questions have arisen in planning for the distribution of large IRAs. To its credit, the IRS has issued many private letter rulings, most of which have been favorable to the taxpayer. Many planners rely on these rulings as authority in this area.
Richard S. Franklin is a shareholder of Myers Krause & Stevens, in Naples, Florida, and vice-chair of the probate and trust division’s employee benefit planning committee.
This article is an abridged and edited version of one that originally appeared on page 6 of Probate and Property, March/April 2000 (14:2).