Retirement Benefits Planning Update provides information on developments in the field of retirement benefits law. The editors of Probate & Property welcome information and suggestions from readers.
Three Surviving Spouse IRA Payout Options
A surviving spouse of an IRA account owner who is the designated beneficiary of the IRA has three payout alternatives if the account owner dies before the account owner's required beginning date (RBD). Each of these alternatives, which are not available to a nonspouse, changes the usual application of the minimum required distribution rules to permit the surviving spouse to defer the commencement of minimum required distributions (MRDs) or to spread the MRDs over a longer period, or both.
1. The default provision. The surviving spouse may defer benefit commencement until December 31 of the year in which the deceased account owner would have attained age 70 1/2 had the account owner survived, with MRDs then being made over the surviving spouse's life or life expectancy. Code § 401(a)(9)(B)(iv)(I).
2. The "own IRA" election. The surviving spouse may elect to treat the IRA as the spouse's own IRA, thus deferring benefit commencement until the surviving spouse's own RBD, with MRDs then being made over the life expectancy of the surviving spouse or the joint life expectancy of the spouse and the spouse's own designated beneficiary, subject to the minimum distribution incidental benefit rule (the MDIB rule). Prop. Treas. Reg. § 1.408-8, Q&A 4(b).
3. The rollover option. The spouse may roll over the IRA to a new IRA in the surviving spouse's own name, with the same deferral opportunities described in alternative 2. Code § 408(d)(3)(c)(ii)(II). Note that the rollover (by direct trustee-to-trustee transfer) to an IRA account in the name of the deceased account owner instead preserves the default provision results. PLR 9418034.
If other assets are available to the surviving spouse, maximum deferral allows continued investment of the IRA assets in the income tax-free IRA environment (unreduced by the income tax payable on distribution) and is likely to produce the greatest benefits for the surviving spouse.
The Elusive "Own IRA" Election
Due to the nature of the "own IRA" election, it may not be clear whether the surviving spouse has made an "own IRA" election (or whether the default provision instead applies) until the time at which default rule distributions must commence. Under proposed Treasury Regulations, a surviving spouse elects to treat the IRA as the spouse's own IRA by taking an action that is inconsistent with the account's remaining the decedent's account (specifically, by making a contribution to the IRA or by failing to receive MRDs at the time that they would be required to begin if the IRA were the decedent's IRA). Prop. Treas. Reg. § 1.408-8, Q&A 4(b). Private letter rulings state that these two election actions are not exclusive and that the rollover of an IRA ac-count to a new IRA in the surviving spouse's name also constitutes an "own IRA" election. PLR 9534027.
In general, there is neither a time deadline before which a surviving spouse must make a rollover following an account owner's death nor any requirement that the distribution that is rolled over be a distribution of the entire IRA account. Unless a distribution from an IRA is an MRD or one of a series of substantially equal periodic payments payable over a specified period of 10 years or more or over a life expectancy period, the surviving spouse may roll over the distribution. Code § 402(c)(4). The spousal rollover opportunity has been typically construed as an overlay on the MRD rules. For example, a surviving spouse may roll over all or part of a deceased account owner's IRA account even though the rollover occurs after the decedent's RBD has occurred, after MRDs have commenced or after the surviving spouse's own RBD has occurred.
Foreclosing the "Own IRA" and Rollover Options
Recent private letter rulings relating to pre-age 59 1/2 surviving spouses appear to take what had been viewed as a default provision, applicable until a later election is made, and recharacterize it as a choice between mutually exclusive options to be made on the deceased account owner's death. PLRs 9418034 and 9608042 state that an irrevocable election of the default provision would occur at the time that a pre-age 59 1/2 surviving spouse first received IRA distributions from a decedent's IRA and failed to pay the 10% early distribution tax imposed on pre-age 59 1/2 distributions. In these rulings, the IRS adopts the view that the exception to the early distribution tax for distributions made to a beneficiary on or after the death of the account owner (which clearly applies to distributions received from an account in the deceased account owner's name under the default provision) does not apply if the surviving spouse has elected to treat the account as the spouse's own IRA (effectively transforming the spouse from a death benefit beneficiary to an account owner). The failure to pay tax is construed to be an election out of the "own IRA" election option.
Finally, in PLR 9842058, the IRS has suggested that a surviving spouse's rollover of a deceased account owner's account to the spouse's own IRA (presumably completed some time after the decedent's death) will "relate back" to the decedent's date of death, apparently foreclosing any post-death treatment of the account as the decedent's IRA under the default provision during the time before the rollover.
Planning for the Younger Spouse
For a surviving spouse who is younger than the deceased account owner, the default provision accelerates the commencement of benefits. Thus, rollover to the spouse's own IRA is preferred, at least if the spouse is over age 59 1/2 or does not expect to withdraw funds from the IRA before attaining 59 1/2. If the surviving spouse anticipates pre-age 59 1/2 withdrawals of a portion of the IRA account balance, however, planning is necessary to avoid the 10% tax on early distributions while at the same time maximizing the opportunity to defer distribution of the balance retained in the IRA.
To achieve the objectives of having access to funds, in part, and maximum deferral, in part, the surviving spouse could roll over a portion of the IRA targeted for deferred distribution while retaining the balance in the decedent's IRA, available for distribution under the default provision. Assuming that (1) the rollover is completed before any distributions are made to the surviving spouse as beneficiary of the IRA and (2) the "failure to pay the 10% tax" election is viewed as a prospective election of the default provision, this strategy should work under PLRs 9418034 and 9608042. If, however, the IRS adopts the "relation back" position of PLR 9842058, post-rollover distributions from the deceased account owner's IRA may be subjected to the 10% tax on the theory that even a partial rollover is an "own IRA" election that prevents the default provision's applying.
PLR 9842058 describes an apparently safe but more complex alternative. That ruling approved a rollover of a deceased account owner's IRA into two IRAs in the spouse's name. One IRA was funded with an amount that was intended to provide periodic distributions to the surviving spouse that were projected to cover the spouse's needs through age 59 1/2. Payments were arranged to satisfy the exception to the 10% tax for a series of substantially equal periodic payments over the life expectancy of the designated beneficiary. Code § 72(t)(2)(A)(i); Notice 89-29, 1981-1 CB 662. Periodic distributions from (and measured by the balance of) just one of several IRAs are permitted because the rule that requires all IRAs to be aggregated for MRD purposes does not apply for the 10% excise tax purposes. If periodic payments are terminated or modified before the later of the fifth anniversary of the initial payment or the beneficiary's reaching age 59 1/2, the 10% tax for all pre-59 1/2 payments is assessed with interest. The second rollover IRA would be expected to defer any distributions until the spouse attains age 59 1/2.
The concept that a surviving spouse's interest in a deceased account owner's IRA must be as a beneficiary or as an account owner from the time of a decedent's death may appear to be a logical conclusion. Nevertheless, there does not seem to be any statutory (or regulatory) basis for this rule. Because applying a relation back concept as a general rule would create a number of traps for the unwary, it is hoped that the IRS will abandon this approach. In the meantime, if separate IRAs are established before the account owner dies, one may be administered under the default pro-vision and the other as the spouse's own IRA without requiring potentially detrimental post-death decisions. If a client whose spouse is under age 59 1/2 has a concentration of assets in IRAs, that precaution is a simple one.
Retirement Benefits Planning Editor: Harvey B. Wallace II, Joslyn Keydel & Wallace, 211 West Fort St., Suite 2211, Detroit, MI 48226-3270.Probate & Property Magazine is published six times annually and is included in section members' annual dues.