Why Your Family Won’t Qualify for the New IRA Rollover Opportunity
Come January 1, 2008 every non-spouse designated beneficiary will have the option to rollover an inherited IRA and stretch distributions. However, in order to take advantage of this opportunity your estate plan must be setup correctly to qualify for this rollover opportunity. You are not entitled to a rollover, you must prove you meet the technical legal requirements. Let’s take a look at why your family would not qualify for the new IRA rollover opportunity.
Congress recently opened the door to allow a non-spouse beneficiary to rollover an IRA or 401(k) and stretch distributions over the beneficiary’s lifetime. 2007 was interesting because this new option was not required by all retirement plan administrators, it was optional. At the end of the day, there was confusion and to answer the question if it was even possible for a non-spouse beneficiary to qualify for a rollover you would have to check with each plan administrator.
In 2008 the IRS is attempting to put an end to the confusion and requiring that all plans provide the option for a non-spouse beneficiary to rollover an IRA. This is great news and a great opportunity for those families positioned to take advantage of it. For families that are not prepared, it is simply another sand-trap.
So what is the big sticking point?
Designated Beneficiary. Those two words are critical to how the IRS treats and taxes the transfer of an IRA or other qualified retirement account from the account holder to the beneficiary(ies). You may be thinking, well, as long as I have a beneficiary I am in good shape. That would be wrong, the IRS has dedicated volumes of paperwork to making it perfectly clear to those who are listening that not every beneficiary qualifies as a designated beneficiary.
The biggest example of a beneficiary that is not a designated beneficiary is if your IRA goes into your probate estate either on purpose or by accident. The IRS absolutely hates it when an IRA goes into a probate estate and will almost certainly treat the event as a transfer to a non designated beneficiary and your family would not be able to take advantage of the rollover option without jumping through a lot of costly hoops.
But I went to an attorney and setup a complete estate plan including a living trust etc.
That’s great. I’m glad you’ve embraced personal responsibility for your estate plan rather than run from it like a lot of people according the surveys over the last 10 years. However, all trusts are not the same. Some come from old books in a law library (I’ve seen trust documents reference King George in the Rule Against Perpetuities language. I don’t know if I’m more surprised that the attorney presented it to their client with a straight face or that the client did not think twice about who drafted the trust when they saw it.), some come from computer drafting assembly programs written in imprecise language by people that may or may not be experienced tax attorneys, and some are even drafted by competent attorneys that get it right. Simply having a trust or having an estate plan does not automatically mean your family will qualify for the new rollover benefits.
How can I qualify for rollover treatment?
The IRS has very specific rules for how a trust can qualify as a see through trust and treated as a designated beneficiary. The top level bullet point requirements are:
- The trust must be valid under state law;
- The trust must be irrevocable or become irrevocable when the IRA owner dies;
- The trust beneficiaries must be identifiable from the trust instrument;
- Proper documentation must be provided to the IRA custodian.
Seems simple enough right? Remember, this is the IRS we are dealing with and they take income tax deferral very seriously because they think they are losing money. They have regulations on top of regulations on top of Private Letter Rulings and court decisions defining each one of those bullets in extensive detail. There is enough material to write a book on those four issues, and people have. I can’t get into detail on all of them here because it would take forever.
The most common stumbling block for inexperienced drafters is the requirement that beneficiaries be identifiable from the trust document. Many trust documents I’ve seen coming in to my office do not contain adequate restrictive language to achieve compliance with this rule. If you don’t have this language or if the people administering your estate handle the IRA or retirement funds incorrectly you have a big flashing sign to the IRS saying your family does not qualify for rollover treatment.
Rollover treatment is a privilege, not a right. Your family will not qualify for rollover treatment if you do not follow the rules in your estate plan. Make sure you and your attorney understand the requirements and that your estate plan doesn’t fall apart on this critical issue.
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Index Tags: estate planning, living trust, probate, taxes
