Spouse as IRA Beneficiary
Ed Slott, in a PBS fund raising program, “Stay Rich Forever and Ever”, implied there was something wrong with naming your spouse as your IRA beneficiary rather than children or grandchildren. Is there some legal restriction or penalty? If you predecease, your spouse would have access, if needed, to those monies, and can just as easily THEN name the children or grandchildren as beneficiaries. So what is the problem?
Permalink Submitted by Alan Spross on Mon, 2008-09-15 18:38
There is only a problem in certain specific situations, no problem for the majority of IRA owners. Some cases which Ed may have been referring to are:
1) People with an estate tax exposure due to total asset amounts in excess of unified credits, actual or projected. If the spouse acquires all assets, even though an unlimited marital deduction applies at the first death, when the surviving spouse passes, all assets are included in that estate. The unified credit amount of the first spouse is not affectively used.
2) The above situation may be addressed by leaving assets directly to non spouse beneficiaries and therefore applying the unified credit amount of the first spouse. Assets can also be left to an A/B trust, where the B trust uses the credit from the first spouse, with income paid to the survivor while survivor is alive. However, IRA RMDs that get moved to the surviving spouse can water down this benefit since some of the assets go back to the spouse and increase the chances of the second spouse incurring estate taxes. It is better to fund the B trust with non IRA assets if enough exist. This is a tradeoff between access to funds vrs estate tax exposures.
3) In mutiple marriage situations, the deceased spouse may not trust the survivor to name the deceased’s children rather than their own, so a trust is needed to assure that.
There is no legal restriction or penalty for naming a spouse. In fact, in a community property state, the other spouse may need to sign off on naming a non spouse. There may be some actual income tax benefits for naming a spouse since they generally have an RMD requirement that is lower than non spouses since they can assume ownership of the IRA.
In fact, your suggestion works well for the majority of people, since most are not in one of the above situations. For the above situations, #3 is probably the most common, since there are many more divorces than taxable estates.
Permalink Submitted by Bruce Steiner on Mon, 2008-09-15 19:26
To the extent the credit shelter (sometimes called the bypass, family, nonmarital or B trust) is the beneficiary, you get to take advantage of the exempt amount, but you give up the rollover and the possible Roth conversion, and you limit the stretchout to the spouse’s life expectancy.
Alan is correct that to the extent the credit shelter trust requires that any amounts be distributed to the spouse, you give up some of the benefit of having the credit shelter trust, since you’re taking money that’s out of the spouse’s estate and throwing it into the spouse’s estate. However, the credit shelter trust need not require that any amounts be distributed to the spouse. Most better drafted credit shelter trust do not require that any amounts be distributed to the spouse.
Bruce Steiner, attorney
NYC
also admitted in NJ and FL
Permalink Submitted by david johnston on Tue, 2008-09-16 19:19
Frankly, I much preferred Ed’s old spartan web format. With all the bells and whistles on this one, I can only hope you get my reply.
Apologies for the delay. The legalese can be dense – like me – but I DID ask for it, and thank you both for your prompt responses.
Al – “unified credit”: I take it this is all of the estate’s assets’ value, up to the current Estate Tax Exemption limit. I think I follow #1 after that.
Bruce – with the IRA from the first spouse in the trust, “you give up the rollover and the possible Roth conversion, and you limit the stretchout to the spouse’s life expectancy.” What “rollover” am I giving up? Is it to the beneficiaries of the trust – presumably children or grandchildren – thus, as you say, limiting “the stretchout to the spouse’s life expectancy.”? With respect to Roth, I appreciate that once in the trust, one cannot “monkey” with the type of IRA; indeed, the strategy to be followed would seem to be to convert TIRAs into Roths at the earliest convenience. Yes, taxes will have to be paid, diminishing the total amount on hand to appreciate or to be passed on, but let that be considered an early installment on the final inheritance distribution.
You speak of the trust not “requiring” spousal distribution, but can it not be structured to “permit” withdrawals, tax free, up to the current estate tax exemption limit, to supplement cash flow for expenses if the flow from the surviving spouse is inadequate? This would not increase the risk of the other estate exceeding it’s unified credit.
Thanks for your help.
DBRJ
Permalink Submitted by Bruce Steiner on Tue, 2008-09-16 19:31
The income tax disadvantages of leaving an IRA to a credit shelter trust are:
1. Distributions generally must be made over the spouse’s life expectancy, whereas (i) if you leave the IRA to the spouse, she can roll it over, name new beneficiaries, possibly convert to a Roth, and have the distributions payable over a longer period of time, or (ii) if you leave the IRA to or in trust for the children, distributions can be taken over the children’s (or the oldest child’s) life expectancy.
2. You can set up the credit shelter trust to prohibit, permit or require distributions of as much, as little, all or none of the income, principal, both, or neither, as you wish. For most clients whose crystal balls aren’t that good, it generally makes sense to have the trust be as flexible as possible, so that the family can do what’s best from time to time.
Bruce Steiner, attorney
NYC
also admitted in NJ and FL
Permalink Submitted by david johnston on Tue, 2008-09-16 19:59
Thanks for the clarification.
WHAT can she “roll it over” to?
DBRJ
Permalink Submitted by Alan Spross on Tue, 2008-09-16 20:35
A surviving spouse can “roll it to” an IRA in their own name, ie they are no longer the beneficiary of an inherited IRA, but the owner of the IRA as if it had been theirs all along.
Yes, “unified credit” is the amount each taxpayer can exempt from federal estate taxes. It is currently 2 million, but will rise to 3.5 million next year. From there, it is scheduled to disappear for 1 year, but Congress will undoubtedly intervene and hopefully establish a new credit amount that will last for a generation or so rather than bouncing around in large amounts and making planning much more difficult. The best guess is that the new exemption will be somewhere in the range of 3.5 million to 5 million. However, many states have their own exempted amount now, some far less than the federal limit.
Permalink Submitted by david johnston on Wed, 2008-09-17 02:49
Aha! I think I see the difference between “leaving” an IRA and having it “rolled over”. I thought “leaving” WAS essentially combining it with an existing, whereas it must be separately rolled over to do that.
Yes – one gets a sore neck following the annual bouncing of the estate tax limit. With the lower State limits, you are referring to STATE estate taxes, separate from Federal. I believe NC does not have a State Estate tax, but you may not feel qualified to address that, and down the road I will need to deal with that locally in revising my will.
My thanks again to both of you for your help and patience.
DBRJ
Permalink Submitted by Alan Spross on Wed, 2008-09-17 03:13
Actually, the surviving spouse can assume ownership by actively assuming ownership OR in some cases by not acting.
The RMD rules state that if a sole spouse beneficiary FAILS to take their RMD from an inherited IRA, they are deemed to have assumed ownership of that IRA by default.
Permalink Submitted by david johnston on Wed, 2008-09-17 03:33
Unless the sole spouse beneficiary is already past 71.5 and RMD is mandatory.
Permalink Submitted by Alan Spross on Wed, 2008-09-17 03:56
Even then the rule applies. The following is copied from the IRS Regs 1.408-8 Q&A 5. Note last 3 paaragraphs:
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Q–5. May an individual’s surviving spouse elect to treat such spouse’s entire interest as a beneficiary in an individual’s IRA upon the death of the individual (or the remaining part of such interest if distribution to the spouse has commenced) as the spouse’s own account?
A–5. (a) The surviving spouse of an individual may elect, in the manner described in paragraph (b) of this A–5, to treat the spouse’s entire interest as a beneficiary in an individual’s IRA (or the remaining part of such interest if distribution thereof has commenced to the spouse) as the spouse’s own IRA. This election is permitted to be made at any time after the individual’s date of death. In order to make this election, the spouse must be the sole beneficiary of the IRA and have an unlimited right to withdraw amounts from the IRA. If a trust is named as beneficiary of the IRA, this requirement is not satisfied even if the spouse is the sole beneficiary of the trust. If the surviving spouse makes the election, the required minimum distribution for the calendar year of the election and each subsequent calendar year is determined under section 401(a)(9)(A) with the spouse as IRA owner and not section 401(a)(9)(B) with the surviving spouse as the deceased IRA owner’s beneficiary. However, if the election is made in the calendar year containing the IRA owner’s death, the spouse is not required to take a required minimum distribution as the IRA owner for that calendar year. Instead, the spouse is required to take a required minimum distribution for that year, determined with respect to the deceased IRA owner under the rules of A–4(a) of §1.401(a)(9)–5, to the extent such a distribution was not made to the IRA owner before death.
(b) The election described in paragraph (a) of this A–5 is made by the surviving spouse redesignating the account as an account in the name of the surviving spouse as IRA owner rather than as beneficiary. Alternatively, a surviving spouse eligible to make the election is deemed to have made the election if, at any time, either of the following occurs —
(1) Any amount in the IRA that would be required to be distributed to the surviving spouse as beneficiary under section 401(a)(9)(B) is not distributed within the time period required under section 401(a)(9)(B); or
(2) Any additional amount is contributed to the IRA which is subject, or deemed to be subject, to the lifetime distribution requirements of section 401(a)(9)(A).
(c) The result of an election described in paragraph (b) of this A–5 is that the surviving spouse shall then be considered the IRA owner for whose benefit the trust is maintained for all purposes under the Internal Revenue Code (e.g., section 72(t)).
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