"Estate Bypass" - Spousal Rollover when the Estate is Beneficiary
Many families aim to transfer wealth smoothly, especially when retirement accounts are involved. However, mistakes with beneficiary designations can trigger complex tax rules and reduce the value passed to heirs. One common situation arises when an estate becomes the beneficiary of an IRA. This article explains what options exist, especially for surviving spouses, and how to resolve these cases using IRS Private Letter Rulings (PLRs).
How Estates Become IRA Beneficiaries
An estate can end up as the beneficiary of an IRA in two main ways:
- The IRA owner names the estate directly as the beneficiary on the form.
2. No beneficiary is named, and the custodian defaults to the estate based on internal policy.
In both cases, the estate becomes a non-designated beneficiary. This creates a problem because non-designated beneficiaries face strict payout timelines. These rules can result in accelerated taxation and reduced flexibility.
Why Naming an Estate as Beneficiary Limits Options
When an estate inherits an IRA, the payout period depends on when the original IRA owner passed away:
- If death occurs before the required beginning date (April 1 of the year after turning 73), the 5-year rule applies. The entire IRA must be withdrawn within five years, with no required minimum distributions (RMDs) during that time.
- If death occurs on or after the required beginning date, the estate must take annual RMDs over the remaining life expectancy of the deceased.
Compare this to the 10-year rule available to non-eligible designated beneficiaries (like adult children). Under that rule, beneficiaries can stretch withdrawals—and taxes—over ten years. Naming the estate prevents this benefit.
Correcting the Problem with a Spousal Rollover
Sometimes, the estate ends up as the beneficiary by accident. A missing or outdated form can cause the custodian to default to the estate—even if the spouse was meant to inherit.
Fortunately, a possible solution exists: a spousal rollover, even when the estate is listed as beneficiary. The key lies in the use of Private Letter Rulings (PLRs).
Understanding Private Letter Rulings (PLRs)
PLRs are decisions issued by the IRS to respond to specific taxpayer requests. Although PLRs apply only to the individual who requested them, they can indicate how the IRS interprets certain tax scenarios.
Several PLRs have created a trend: if the surviving spouse is the sole beneficiary of the estate, a spousal rollover may be allowed, even if the IRA named the estate instead of the spouse.
Notable PLRs Supporting Spousal Rollovers:
- PLR 201430020
- PLR 201430027
- PLR 201821008
- PLR 201839005
Each of these rulings permitted a spousal rollover in situations where an IRA or workplace retirement plan listed the estate as beneficiary. In these cases, the IRS allowed the surviving spouse to roll the inherited IRA into her own IRA, provided she was the sole heir.
Another relevant ruling, PLR 200343030, expanded flexibility for non-spouse beneficiaries. Although it did not permit rollover treatment, it allowed the creation of inherited IRAs for non-spouse beneficiaries when the estate was named. However, the payout rules tied to the estate still applied.
Important Considerations for a Spousal Rollover
Even if prior PLRs support the transaction, a spousal rollover is not guaranteed. Success depends on several factors:
- Custodian cooperation: Not all custodians allow estate bypass rollovers. Some have internal procedures to review such requests. One custodian refers to this as an “estate bypass,” though this term may vary.
- Legal documentation: The spouse must show she is the sole estate beneficiary. Estate documents, including the will or probate filings, must confirm this.
- Timeliness: The process should occur before the estate closes and while the assets remain in the estate-owned inherited IRA.
Working with a knowledgeable financial advisor and estate attorney is essential when navigating this process.
How to Prevent Estate-As-Beneficiary Situations
Preventing this issue is often easier than fixing it. Take these two steps to protect your retirement accounts:
- Review all beneficiary forms regularly. Confirm that each IRA or retirement account lists the correct primary and contingent beneficiaries. This should include accounts opened years ago, which may have outdated designations.
- Store forms securely and accessibly. Ensure copies of beneficiary forms are available to your family or advisor. If a form is lost and no record exists, the custodian will default to internal rules—often naming the estate.
FAQ
Can a spouse roll over an IRA if the estate is the listed beneficiary?
Yes, if the spouse is the sole beneficiary of the estate, and the custodian permits it, a spousal rollover may be possible using guidance from Private Letter Rulings.
What is the 5-year rule for inherited IRAs?
If a non-designated beneficiary, like an estate, inherits an IRA and the owner died before their required beginning date, the account must be emptied within five years.
What happens if no IRA beneficiary is listed?
If no form is on file, the custodian often defaults to the estate. This can trigger less favorable tax rules and limit spousal rollover options unless corrected.
Are PLRs binding for everyone?
No. PLRs apply only to the individual who requested them. However, a consistent pattern of PLRs can guide similar decisions and show IRS interpretation.
How can I prevent estate inheritance issues with IRAs?
Keep your beneficiary forms up to date and check them after life events like marriage, divorce, or the birth of a child. Store copies where your executor or advisor can access them.
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.