Broker Check

A Favor? From the IRS?

September 19, 2016

Every now and then, the IRS does investors a favor. And every now and then, investors think about their estate. While IRS rulings and estates may seem like boring reading, anyone who is married to a spouse with a retirement account should pay attention to this one.

In a recent Private Letter Ruling, the IRS allowed a spouse to roll over her deceased husband’s IRA, even though the IRA named her husband’s estate as beneficiary. IRA stands for Individual Retirement Account, which means that an individual owns it. An estate is not an individual. Also important for you to know is that all distributions from IRAs are taxed as ordinary income. If an estate “receives” a $750k IRA as a distribution, that estate has $750k in taxable income that year, which creates a very ugly tax bill.

Based upon a long-standing Treasury Regulation, the IRS generally treats the distribution to the estate as a taxable event, leaving the estate beneficiaries unable to roll over the IRA without income taxation. In this particular case, because the husband’s estate was a trust that had the surviving spouse as sole beneficiary and as the trustee with sole discretion over any distributions, the IRS held that its general rule did not apply, and a roll over was granted. While this is ultimately a great result for this investor, please know that this Private Letter Ruling is not binding precedent, and is an expensive way to remedy a fairly common (and avoidable) pitfall.

So, what have we learned? REVIEW YOUR BENEFICIARIES. Every investor should make sure that the beneficiaries listed on accounts are correct, and that there are no unintended consequences because of uninformed decisions. While trusts can be useful for many things, the couple in this example could have avoided the great expense of a Private Letter Ruling by naming the surviving spouse as beneficiary directly. If you have minors listed as beneficiaries, be aware of the limitations and consequences of that choice. If you wish to place limitations on beneficiaries through a trust, that trust must be created ahead of time and named as beneficiary.

In short, ask your financial planner, or speak with an estate attorney, to make informed decisions for you and your beneficiaries. Better yet, ask your financial planner and your estate attorney to review your estate plan and documents together so you have cohesive guidance on where your money goes after you die.

Although the information is gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. Neither FSC Securities Corporation nor its registered representatives offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.