By Edward A. Slott

Whether “Disclaimer Is Effective to Change the Designated Ben- eficiary” (PLR 2000-13041) becomes a landmark ruling remains to be seen; for now, the taxpayers that requested this ruling and received a favorable response can stretch required distributions for decades. A disclaimer by the personal representative of the second spouse to die was used to change the designated beneficiary and allow required distributions to be based on the life expectancy of younger beneficiaries (the children), even though the spouse was the designated beneficiary at the time of the IRA owner’s death.

Facts of the Ruling

A married couple each had IRAs and named each other as the primary beneficiary. The second (contingent) beneficiary on each of their IRAs was a trust. Their two children were equal beneficiaries of the trust and the trust qualified as a designated beneficiary under the various IRS rules [See IRS Proposed Regulations section 1.401(a)(9)-1, D5 and D-6].

In 1998, the couple was killed in an auto accident. Both died before their required beginning dates. Since the wife died first, the husband was the beneficiary of her IRA. When the husband died a few days later, the trust became the beneficiary of his IRA. The husband’s own IRA was not at issue since the oldest of the two children was now the designated beneficiary through the trust. However, the question of the designated beneficiary of the wife’s IRA, inherited by the husband, was a bit more complicated. The children were advised to have the husband’s estate disclaim the wife’s IRA.

A disclaimer is a legal, written refusal of a gift or inheritance by someone otherwise entitled to receive the property. Once the property is refused (disclaimed) it passes to the next named beneficiary. To be a qualified disclaimer under the tax code, the disclaimer must be in writing and made within nine months of the date of death or transfer. The individual cannot have accepted, taken possession, or used the disclaimed property and has no say as to who receives the property; it must pass directly to the next named beneficiary. The disclaimer also must be valid under state law.

Why refuse an inheritance? In this case, the children had two objectives:

To save estate tax. Because the wife left most of her property to her husband, her estate (after the marital deduction) would be zero and her estate tax exemption ($625,000 in 1998, when the deaths occurred) wasted. The husband’s estate would inherit the IRA and it would be subject to estate tax. The husband’s estate cannot take credit for the unused estate tax exemption in the wife’s estate. If the exemption (the unified credit) is not used, it is lost. The loss of a $625,000 estate tax exemption means an additional $246,250 in estate tax. Therefore, the children wanted to salvage the wife’s unified credit by having the husband’s estate disclaim the IRA. Once the husband’s estate disclaims, the IRA passes to the contingent beneficiary, the wife’s trust, which names the children as beneficiaries.

Also, in the case of a double death, a disclaimer has no effect on the children receiving the IRAs, but only on how the amount they receive is divided between the two estates. By having one parent’s estate disclaim, the children merely receive the property from one estate instead of the other. In the more common disclaimer situation where only one spouse has died, the children will not receive the property if they disclaim it. In this case, the disclaimer by the personal representative of the husband’s estate made no difference to the beneficiaries except for the IRA distribution and estate tax advantages.

To change the designated beneficiary of the IRA. Because the husband was the designated beneficiary of the wife’s IRA, his age was used (for life expectancy purposes) to calculate the required distributions. The children wanted to use the age of the oldest child and stretch distributions over a much longer life expectancy. The personal representative of the husband’s estate disclaimed the husband’s interest in the IRA as well as any fiduciary interest (as trustee of the trust), so that the IRA would pass to the trust benefiting the two children. Once the disclaimer was executed, the children asked the IRS if they could treat the IRA as inherited, allowing the oldest child to be treated (through the trust) as the designated beneficiary and the distributions to be stretched over that longer life expectancy.

The IRS, in the first ruling directly on point, stated that a postdeath disclaimer can be used to change the designated beneficiary and in turn extend the life of the IRA. Previous rulings that dealt only with a death after the required beginning date (RBD) did not allow this. In two other rulings, which did address an IRA disclaimed when the IRA owner died before the RBD, the disclaimer allowed a change in beneficiary but the IRS did not state whether it would allow the longer life expectancy (PLR 9226058), and additional estate planning concerns clouded the issue in the other (PLR 1999-47036).

This most recent ruling (PLR 2000-13041) supplied the first direct answer to the question “Will a disclaimer to a younger beneficiary allow the longer life expectancy of the younger beneficiary to be used when the IRA owner dies before his RBD?” In this ruling, the IRS’s answer is yes.

Beneficiary vs. Designated Beneficiary

To be clear, for estate and gift tax purposes, a qualified disclaimer can be used to change the beneficiary, the person or entity that will actually inherit the IRA. That is not what made this a groundbreaking ruling. PLR 2000-13041 establishes that a disclaimer can change both the beneficiary and the life expectancy for computing required IRA distributions.

There is a difference. The designated beneficiary is the beneficiary whose life will be used to determine the required minimum distributions for the inherited IRA. The beneficiary and the designated beneficiary are not always the same.

Had the IRS ruled against allowing the disclaimer to be effective to change the designated beneficiary, the beneficiary still would have been the trust, but the designated beneficiary would have been the deceased husband, requiring distributions to be taken over his remaining life expectancy. Because of the favorable IRS ruling in PLR 2000-13041 that allows the disclaimer to change the designated beneficiary, both the beneficiary and the designated beneficiary can be the same; therefore, the children were allowed to stretch required distributions based on the age of the older child.

In a previous ruling (PLR 1999-31048) where the IRA owner also died before his RBD and had multiple beneficiaries named on the account, the IRS permitted each beneficiary to use his own life expectancy. The question of the children using their own life expectancies was not raised in PLR 2000-13041. Even if it had been, it probably would have been denied because in this case, the beneficiary was a trust and the two children were beneficiaries of the trust; in PLR 1999-31048, the beneficiaries were all named as direct beneficiaries rather than through a trust.

Even though the trust is merely a conduit, the IRA has ruled (in PLR 1999-03050) that a trust is distinct from naming the beneficiaries directly (without a trust), making it unlikely that the IRS would have allowed trust beneficiaries to use their own life expectancies. Given recent IRA-friendly rulings, however, it may be worth the effort for taxpayers in such a situation to request a ruling.

This disclaimer ruling surprised many tax and legal professionals because allowing a disclaimer to be used to change the designated beneficiary was inconsistent with the IRS’s previously stated position. But the new position makes practical sense. After all, a change in beneficiary before the RBD would otherwise effectively change the designated beneficiary even if that change was to a younger beneficiary whose life expectancy would lengthen the distribution period. The designated beneficiary should be locked in once the IRA owner reaches his RBD, but not before.

What the Decision Means

One PLR should not be the cornerstone of a retirement plan, especially one that entails planning to die before reaching one’s RBD. In this ruling, the IRS in effect treated the postdeath disclaimer as a change of beneficiary occurring immediately before death. Taxpayers that have not yet reached their RBD can change designated beneficiaries as often as they like. After the RBD, a taxpayer’s designated beneficiary is locked in and a change of beneficiary cannot effectively lengthen the distribution schedule. The only time a change in beneficiary will effectively change the designated beneficiary after the RBD is when it is to an older beneficiary or one with a shorter life expectancy.

Therefore, taxpayers past their RBD cannot rely on the disclaimer ruling. Each PLR is specific to the facts and circumstances of the particular situation. For example, it could be that the IRS ruled favorably in PLR 2000-13041 because of the unusual double deaths. For state law purposes, an individual that disclaims a gift or inheritance is treated as predeceasing the individual (donor/gift giver/decedent) that had made the gift or bequest.

Importance of Naming a Contingent Beneficiary

This ruling highlights the significance of not only naming a beneficiary but naming a contingent (secondary) beneficiary, which will receive the property disclaimed by the primary beneficiary. Naming a contingent beneficiary should not be taken lightly. A disclaimer is in effect a Plan B in case the primary IRA beneficiary disclaims. The contingent beneficiary takes on new importance in light of the planning opportunities presented in PLR 2000-13041 but should not be the focus of a retirement plan. The disclaimer plan is often a bandage approach to correct a defective estate plan. A better plan is to initially name a younger beneficiary as the designated beneficiary and a spouse as the contingent, because changing to a shorter life expectancy is always permitted. However, this is not practical if the spouse needs the assets for living expenses. In such a case, estate planning takes a back seat to the financial security of the surviving spouse.

Roth IRA Effect

Roth IRA owners are deemed to have died before their RBD, regardless of their age at death, because there is no RBD for a Roth IRA owner. However, whether this means that all Roth IRA beneficiaries will get a favorable ruling on the disclaimer issue is yet to be determined.

The IRA distribution rules are not covered in Subtitle B. They fall under the income tax section of the IRC in Subtitle A. Yet the IRS ruled that the disclaimer is effective for the IRA distribution rules. This means that the next case could go in any direction. An individual ruling is the only way to be certain a planning strategy will work in a given situation.

Roth IRA conversion denied. The disclaimer ruling request boldly asked the IRS whether it would allow the two children/beneficiaries to convert their inherited IRAs to Roth IRAs. The IRS slammed the door on this request and said that an IRA inherited by a nonspouse cannot be converted to a Roth IRA. Did this denial allow the bigger disclaimer issue to pass without a hitch? Some tax services discussed this ruling as if the Roth conversion request was the primary issue.

Transfer to Separate IRA Accounts Allowed for Beneficiaries

The IRS permitted the beneficiaries to make a trustee-to-trustee transfer from the trust to an IRA for each of them without triggering a tax, as long as the IRAs were maintained in the name of the deceased parent as an inherited IRA. Also, the IRS stated that the required distributions must be made on each child’s inherited IRA account using the life expectancy of the oldest child. q