When Rulings and Regulators Clash
In some cases, state courts rule one way while the IRS rules another. In the end, the IRS is not governed by state court decisions.
Rodriguez discussed an IRS private letter ruling where a late IRA owner had left his account to his daughter. However, the state was a “community property state,” where any amount that was earned or accrued during his marriage could be considered the property of his spouse.
“The spouse went to court against her son, and the state court ruled in her favor. The account had to be transferred,” said Rodriguez, adding that the court assigned a portion of the IRA to the spouse as a spousal rollover IRA. “She filed for a private letter ruling asking the IRS to bless this and the IRS said no because the beneficiary form did not list her. It listed a non-spouse, her son.”
The tax code states that IRA assets are not subject to community property rules. In its private letter ruling, the IRS also ruled that any assignment of assets to the spouse should be treated as a distribution taxable to the son. In the case in question, the son was responsible for an expensive tax bill that might have been avoided if the deceased client’s beneficiary forms were in order.
Rodriguez recommended that advisors and their clients should get the written consent of their spouse if they choose to name someone else as the beneficiary of their IRA in states where the community property rules are in place.
Slott recommends that advisors keep copies of beneficiary forms for every IRA and retirement account owned by their clients, making sure that a beneficiary is named in writing, and also check to see that a secondary or contingent beneficiary is named. If multiple beneficiaries are named, advisors should be sure that each name and share is clearly stated, and that the shares add up to 100 percent, or that fractional shares add up to one.
What Makes a Designated Beneficiary
Account holders might be confused by the difference between beneficiaries and designated beneficiaries. While a beneficiary can be any person or entity, a designated beneficiary must be a living, breathing person, said Andy Ives, another IRA Analyst with Slott & Co.
“As a general rule, never, ever name an estate as a retirement plan beneficiary,” said Ives. “When it comes down to it, the beneficiary choice has to do with the goals—the goals that the original IRA owner had and the goals of the beneficiary. Most of the time, account owners and beneficiaries want to transfer assets in the most efficient way, minimize costs and taxes, and stretch out the distributions for those assets.”