Naming your own beneficiary for an inherited IRA?????

[Kathy]

According to the Wall Street Journal, Fidelity has decided to allow the beneficiary of a decedant's IRA designate their own beneficiary on the account in order to allow the assets to coninue on in tax-deferred status. I am assuming they mean that the second beneficiary would continue to take distributions over the life expectancy of the first minus one for each year that has passed but the article doesn't state that.

It was my understanding that it is trust law and not tax law which prohibits changes to a trust once the grantor (origianl IRA holder) has passed away - they created the trust agreement and once they are gone, no changes can be made???

Is anyone else following Schwab and Fidelity in doing this? Any ideas on why no one has done it in the past but now it's ok? Has something changed or are they just getting bolder and more aggresive?

[John Olsen]

I don't think it's a question of being "bolder" - merely of being less absurdly restrictive. Trustees (including Fidelity)have made administrative policies which are MORE RESTRICTIVE than the Code and Regs require.

In my opinion, the changes we're seeing are simply the overdue responses of hidebound functionaries to the legitimate demands, on the part of their customers, that they be allowed the advantages conferred by Law.

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John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

[Guest David Hammond SRS]

Some thoughts from the Massachusetts Banking Scene on this topic.

An IRA is a trust created by an individual who executes a trust document and funds the trust. A general rule of trust law is that only the grantor of the trust has the province to name a beneficiary who will so benefit from the trust upon the grantor's death.

Upon death the beneficiary merely has a right to receive the property. Beneficiaries are not the grantor or creator of the trust and generally have no right to alter the terms of the trust by naming their own beneficiary.

This has been the generally accepted rule for many years in the IRA business.

It may vary from state to state. It is a real problem and will only continue to grow as the age of existing IRA customers progress with each month and year and deaths of IRA owners are encountered.

In my opinion this change represents the desire of a very large financial institution to modify inconvenient or unclear rules for operational conveniences. Well intened and logical perhaps but as this tendency progesses in other areas more each day it infuses confusion in the already confused, rules-littered landscape of IRA. They probably did get their own legal opinion but it does go contrary to what has been accepted over my 22 years of IRA experience. It makes standing one's ground and keeping the customer and fiduciary's interest on the straight and narrow very difficult to achieve.

In this area where trust law and IRA Regs meet clairification is needed. My advice is to move cautiously and intrepret conservatively until you can get reliable legal opinion or until some general clarifiacation is rendered. (That may prove problematic).

Because any large financial institution chooses to interpret something differently does not necessarily mean that it is correct for everyone or meets

general regulatory muster.

[Kathy]

Hey John, why not tell us what you really think?

But really, I don't think trustees have arbitrarily imposed restrictions on accounts for which they are the fiduciary. It is important to remember that the tax code is not the only set of rules that we have to follow and sometimes it gets complicated trying to match the tax code with other federal requirements and state law. I remember the uproar when the IRS approved (through a private letter ruling) the transfer of a decedent’s IRA to two different trustees, one for each of the two sisters who inherited their father’s IRA. The question I saw raised over and over again was – how could someone, other than the one who created it, change the trust? The IRA holder was the one who executed the trust agreement appointing the trustee and creating the trust and he was the only one with the authority to change the trustee, not the beneficiaries.

Granted, there is nothing in the tax code that I can find which specifically prohibits the non-spouse beneficiary of a decedent’s IRA from naming a beneficiary of their own. However, there is also nothing which permits it either (there is a specific provision for spouses to be able to treat inherited IRAs as there own which implies they may then designate a beneficiary for death distributions). So, since I’m only a lowly accountant, I was hoping to get some legal beagles’ ideas on the other rules and regulations which also might come into play here – such as trust law.

[Guest LMH]

Isn't this more of a state statue issue? And if so, how is Schwab and Fidelity, who obviously have clients in every state, handle this?

[Guest Parker]

The Wall Street Journal article discussed refers to private letter rulings and IRS announcements that permit beneficiaries of inherited IRAs to name their own beneficiaries. Does anyone know what PLRs, IRS announcements, or other authority upon which this opinion is based? I haven't found it yet.

[Guest David Hammond SRS]

Hi Everyone,

Might as well kick this dog til its good and dead.

One of my 90 client institutions has had a real life porblem with this issue in the last two days.

Their bank conusel rendered a legal opinion that Massachusetts Trust Law does not permit a beneficiary of a trust to nominate a beneficiary upon the death of the original trust grantor.

Now apparently IRS is issuing PLR's permitting this on a case by case basis!?

What a country!!

This can then bring up the long standing precept that ERISA Regulations supercede State Laws.

But are IRA's "governed" by ERISA or only "created" by ERISA.......eh? IRA's

are generally not covered under Title I of ERISA.

Goes to prove that if any one thinks the IRA business and its regualtions are simple and straight forward they are naive indeed.

And IRS isn't helping too much these days.

Wheels within Wheels.

[Kathy]

I'm back... The PLR to which I was referring is PLR 9106044 and 9106045 - issued to 2 sisters who were each the beneficiary of 50% of their deceased father's IRA. The article I have from 1997 on this goes on to state that an IRA is a trust whose validity is determined by state law. According to trust law, a trust is not created until the creator or grantor of the trust signs the necessary documents spelling out the terms of the trust. Once the trust is established, only the creator or grantor may alter its terms.... legal advisors could take issue with the IRS' position...

I think that's the position I'm going to continue to stick with.

[John Olsen]

Kathy,

Thanks for the references. My previous remarks notwithstanding (not "inoperative", just "notwithstanding"), I can certainly appreciate the difficulties of a Trustee trying to adhere to the intricate - and sometimes incongruent - requirements of Federal AND State law. Your citatation of the "only grantor may ammend" problem is an apt example.

What incenses me is not the legitimate reluctance of a Trustee to act in areas unclear and potentially hazardous to those to whom the Trustee owes duty, but the knee-jerk response of "it's not our policy" to requests for the most innocuous accomodations.

I recall the functionary at XXX, a VERY well known financial firm, who, when I was discussing an IRA beneficiary designation I was trying to get that Trustee to accept, informed me that "we don't get into things like 'per stirpes'".

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John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

[Guest Martin Silfen]

Doesn't the whole question of who gets the IRA at the death of the beneficiary turn on the proper interpretation of the IRA document in combination with what the original IRA owner said in his beneficiary designation form? Unfortunately these documents are often not clear on this point. If I were the judge interpreting an unclear IRA document I would award the balance of the IRA to the estate of the deceased beneficiary (on the theory that she could have depleted the IRA during her lifetime had she chosen). Then the executor of the beneficiary's estate could transfer the right to further distributions (over the remaining life expectancy of the deceased beneficiary)to whomever the beneficiary of the estate is--presumably the IRA beneficiary's spouse and children, but perhaps someone else.

[Guest P A Weick]

This whole issue can be avoided by having the IRA trust document give the beneficiary a power to appoint any balance remaining in the IRA to whomsoever he or she wishes. we have done this for centuries in the living trust arena and there is a substantial body of law validating the technique.

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[Guest Parker]

What are the tax consequences of allowing the IRA beneficiary to appoint the balance in the IRA? Would the the payments be able to continue on the basis of the original beneficiary's life expectancy (and allow for continued tax deferral), or would the balance be taxable in his or her estate?

[Bruce Steiner]

There are two different issues here:

1. There are numerous PLRs allowing a beneficiary of an inherited IRA to move the IRA from one financial institution to another financial institution. Since the beneficiary could have simply taken all of the money out of the IRA, there is no reason not to let him/her move the IRA to another financial institution.

2. It makes very little difference whether the procedure for a beneficiary of an IRA to leave the balance remaining at his/her death to someone is by beneficiary designation or by Will. The effect is the same in either case. Of course, since (except for retirement benefits passing to a spouse) we generally recommend that our clients leave assets in trust rather than outright, we can avoid this issue.

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

[Guest Martin Silfen]

In answer to Parker's question:

1. The beneficiary would not be subject to income tax at death on the IRA balance merely by being able to appoint the balance to another beneficiary. The account would still be income taxable to the person who receives distributions.

2. The account could continue to be paid over the remaining life expectancy of the deceased beneficiary, unless the deceased beneficiary was the owner's spouse and her life expectancy was being recalculated, in which case it would have to all be distributed by the end of the year after the beneficiary's death.

3. However the value of the account would be in the deceased beneficiary's estate for federal estate tax purposes on account of his general power of appointment.

[Guest P A Weick]

The power to appoint at death can be limited to exclude appointment to the beneficiary's estate, creditors or creditors of his or her estate. The account would then not be included for federal estate tax purposes. However, if the beneficiary could draw down the entire account during his or her lifetime, which I think most documents allow, the account would be included in his or her estate anyhow (as a power to appoint to him or herself). If the beneficiary was limited by the document to only receiving the minimum distributions required by law that (plus the limited power at death) might insulate the beneficiary from having the IRA corpus included for estate tax purposes. Just a thought!

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[Kathy]

Wow! Thanks to all - this has been a very helpful discussion! Since we are in the process of amending IRA documents anyway, I think I will look into the issue further. I'll let everyone know if I come across anthing else pertinent to the topic.

Thanks again for the great input!

[Guest John E McGrady III]

One last thought. Treas. Reg. 1.401(a)(9)-1, Q&A E-5(f) is intended to prohibit a plan (including an IRA) from allowing any person to change the beneficiaries of the participant (or IRA owner) after the participant's death. If this rule is violated, the participant will be treated as not having a designated beneficiary for purposes of the minimum required distribution rules. This concern often arises in the situation where a QTIP trust is named as the beneficiary of an IRA and the trust provisions give the spouse a general power of appointment. Ignoring the state law issues, this 401(a)(9) issue will not likely be implicated by giving an IRA beneficiary the ability to name a beneficiary to receive the remaining IRA benefits upon his or her death (i.e., all secondary beneficiaries will be ignored for purposes of the determining who is a designated beneficiary). The only instance in which I can envision a 401(a)(9) problem would be if the IRA were modified to limit the beneficiaries ability to withdrawal from the IRA (thus converting contingent remainderman into vested remainderman). See PLR 9820021.

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[Guest Parker]

This certainly has been an interesting—and timely—topic. I also am in the process of revising our IRA documents, and will be including a provision allowing an IRA beneficiary to name a beneficiary to continue receiving distributions following his or her death. At this point, we’re considering using the language set out below. I’d appreciate feedback on it. Also, I’d like to know whether anyone has read IRA documents featuring this type of provision and, if so, the language used.

Here is my proposed provision:

Death of your Beneficiary. Upon your death, the Beneficiary of your IRA may designate his or her own beneficiary to receive any remaining assets in your IRA in the event your Beneficiary dies before all of the Account assets have been distributed, if such designation is permitted by the estate and trust laws of your Beneficiary’s state of residence. Payments to your Beneficiary’s beneficiary must continue to be made at least as rapidly as your IRA assets would have been required to be distributed to your original Beneficiary.

[BPickerCPA]

To restate the issue that the article discussed, IRS regs have ALWAYS permitted after death distributions to be made to the bene over his or her life expectancy. The question in the article was, what happens if the bene does not live that many years? The tax law permitted the successor in interest, usually the bene's estate and/or heirs, to continue the withdrawal schedule. But the custodians did not always permit this. What Fidelity (and others) are now saying, is that they will permit the withdrawal schedule to survive the bene's life, AND permit the bene to name their own bene, in order to avoid this asset going thru probate.

From a tax law standpoint, there is NOTHING new here. What IS new is the loosening of custodian rules, to permit bene's to avail themselves of all IRS leniencies.

[Guest jvd]

Does anyone know if the IRS has issued any statement on this? I've tried to get a response from Ms. Hoffman at the IRS but I can't get through to her. I agree with John McGrady III but I'm a little more conservative. I don't think you can allow this without putting the plan in jeopardy of losing the RMD joint life option.

[Guest greymann]

Parker,

The only change I would suggest to your provision is not to limit the beneficiary's ability to designate his or her beneficiary to the period of time after the IRA owner's death. I think much of this is being driven by the IRA owner (in particular those with large IRAs), so the IRA owner may want to have these designations arranged before his or her death (of course, the beneficiary can always then change their designation after the IRA owner's death). Thanks for sharing your provision.