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Beneficiary designations: Surviving spouse rollover of IRAs

One aspect of an estate plan that can easily be overlooked involves beneficiary designations on retirement plans. Designating your spouse as a beneficiary comes with several significant benefits.

The surviving spouse is able to roll over inherited benefits into their own retirement plan without tax consequences. And depending on the situation, a surviving spouse may also be able to take required minimum distributions as a slower rate and use a later start date. This means it is important to review beneficiary designations as part of the estate planning process. The rest of this blog discusses what can go wrong if you do not.

Failing to complete beneficiary designation

The IRS recently ruled that a surviving spouse might still be able to benefit from spousal rollover rules even when the beneficiary designation had not been completed properly.

The administrative decision published in April looked at a situation where the person who passed away had failed to designate a beneficiary. The retirement plan document provided that a custodian would distribute the balance of the IRA to the estate when no beneficiary was listed. The surviving spouse was named as the sole executor/beneficiary in the will and intended to roll over the IRA.

Generally, the amount distributed from an IRA is included in gross income. Rollover contributions, however, can be completed without any tax consequence. Add in the additional element of an inherited IRA and the Tax Code does not allow tax-free rollovers. But the definition of inherited IRA does not include an inheritance by a surviving spouse.

This means that acquiring assets from a third party (a trust or the estate) and not a loved one’s IRA poses problems. That was the issue in this case.

Don’t rely on an exception

In the case, the IRS found an exception even though the funds passed through the estate. Justifying the exception the agency looked at two factors:

  • The estate was the beneficiary of the IRA
  • The surviving spouse was the sole executor and sole beneficiary of the estate.

The surviving spouse was basically the payee and was not prevented from taking advantage of a tax-free rollover of the IRA proceeds.

While this was a positive ruling for the taxpayer, the issue could have been avoided with a comprehensive estate plan. It also illustrates how problems can occur when you do not seek the assistance of an estate planning attorney.

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