If the estate is the beneficiary, the beneficiaries who receive the IRA through the estate can set up inherited IRAs and close the estate. They will still never be designated beneficiaries. When the estate is the beneficiary you would follow the rules that apply when there is no designated beneficiary. Those rules say that if the IRA owner diesbefore his Required Beginning Date (RBD) then the 5-year rule applies. If he dies on or after his RBD, then the IRA can be paid out over the deceased IRA owner’s remaining single life expectancy.
This should never happen to you or your clients since you already know that you should never name your estate as your IRA beneficiary. If you name the estate, you cannot have a designated beneficiary and the stretch option is lost. With that said, it still happens all the time.
The estate would assign the inherited IRA out to the beneficiaries named in the will (a distribution of the IRA is not the same as a distribution from the IRA). They would continue taking distributions over the applicable payout period or sooner if they wished. The problem with this scenario is that many financial institutions would continue to make IRA distributions to the estate (instead of the beneficiary named in the will) and force the estate to remain open until the IRA balance was paid out. This meant that some estates would have to remain open for years. That is no longer the case.
This ruling (PLR 200343030) dated July 31, 2003 and released by IRS on October 24, 2003 was the first ruling to say that the IRA can be transferred to one or several inherited IRAs for the benefit of the beneficiaries of the estate.
Facts of the Ruling
The IRA owner died at age 71 in 2002, so he died after his RBD. He did not name a designated beneficiary so his estate became the beneficiary. Under his will, his IRA was left to his three children in equal shares. This ruling was requested by one of those children, his daughter. She made the following four requests in the ruling:
- That her 1/3 interest could be separated and held in an inherited IRA for her own benefit.
- That the separate IRA could be created by a trustee-to-trustee transfer (which would be titled “Taxpayer A (Deceased) f/b/o Taxpayer B, beneficiary thereof”).
- That she would keep the name of the deceased IRA owner (her father) on the account and take her share of required distributions over the deceased IRA owner’s remaining single life expectancy, using her father’s age as of his birthday in the calendar year of his death reduced by one for each calendar year going forward.
- That the transfer of her 1/3 interest in the inherited IRA would not be a taxable distribution, since it was done as a trustee-to-trustee transfer and was not a rollover (which cannot be done by a non-spouse IRA beneficiary).
IRS ruled favorably on all of the above ruling requests, but they did make clear that even though she is setting up an inherited IRA, the separate account rule would not apply since she was not a designated beneficiary. IRS said, “The ‘separate account’ rules are not available to beneficiaries of an estate.”
This means that she cannot take distributions based on her own life expectancy. She must use her deceased father’s remaining single life expectancy.
IRS also reminded readers of the ruling that “only individuals may be designated beneficiaries” and that “a person who is not an individual, such as the employee’s estate, may not be a designated beneficiary.”
This ruling and many others that followed should be shown to IRA custodians who up to now have been requiring the estate of the deceased IRA owner to remain open until the inherited IRA balance is paid out in full. Now the process should be much easier. The IRA can simply be assigned to one or more inherited IRAs. This would also work if the IRA is payable to a trust. Of course, this only becomes an issue when the estate becomes the beneficiary due to poor planning or neglect. None of this would have ever happened if a designated beneficiary were named on the IRA beneficiary form.