Fixing a Bad Beneficiary Designation After Death…Not So Fast!
After a decedent’s death, a personal representative or trustee often discovers that a decedent’s individual retirement account (“IRA”) beneficiary designation is wrong, incomplete or missing. Many people think that, by fixing this beneficiary designation via court order, such a court order will bind the Internal Revenue Service (“IRS”) as to the determination of the beneficiary designation. However, as shown in private letter ruling (“PLR”) 201628004, this is not always true.
A decedent had 2 IRAs which were maintained by a custodian A. He named as beneficiaries; trust C -50%, trust D-25% and E-25%. All trusts qualified as “see through” trusts. A “see through” trust has been discussed in a prior blog.
Custodian A merged into custodian B, which required decedent to prepare a new beneficiary designation. Decedent inadvertently named his estate Apparently the decedent thought he was just moving the IRA from custodian A to custodian B and never intended that his beneficiary designation be changed.
The trustees obtained a court order that the beneficiary of the IRA were the trusts as originally designated and was “retroactively effective as if such designation was made on the date Decedent signed the beneficiary designation form for IRA X”. So was this valid for the IRS? NO!
The estate was named as the beneficiary and in accordance with Treasury regulation section 1. 40(a)(9)-4, Q&A-3 an estate is not a “designated beneficiary” and, as such was bound by the shorter time periods to pay out the IRA. The IRS noted that, even though a court order was entered, an order can not CREATE a beneficiary designation. A retroactive reformation of an instrument is NOT effective to change the tax consequences of a completed transaction.
The PLR referred to Estate of La Meres V. Commissioner… ” [w]hile we look to local law in order to determine the nature of the interests provided under a trust document, we are not bound to give effect to a local court order that modifies the dispositive provisions of the document after respondent has acquired rights to tax revenues under its terms”. The IRS also referred to Van Den Wymelenberg v. United States, where the court noted “federal tax liabilities would remain unsettled for years after their assessment if state courts and private persons were empowered to retroactively affect the tax consequences of completed transactions and completed tax years”
ADVICE: CAREFULLY review your beneficiary designations ESPECIALLY if you change custodians. Confirm with the custodians what they have on record. If you do not have the proper beneficiary, not only will the incorrect people receive the proceeds, but adverse tax consequences could result.
WORD OF THE WEEK: Custodian is an agent that performs various duties on behalf of a client . Such duties can include, among other duties, holding securities in custody, executing financial transactions, and collecting periodic cash flows from investments. An IRA custodian serves in the capacity of an IRS approved custodian for retirement accounts. If the financial institution is a bank, it is already approved by default to serve as an IRA custodian. Brokerage firms and mutual fund companies must apply to the IRS to be approved to serve as custodians. Examples of custodians of IRA accounts are Vanguard, Schwab, Raymond James, etc.
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