The top five things practitioners need to know about IRAs now: a discussion of state law, case law, and other considerations.

• Author: Lynch, Kristen M.
• Position: Individual retirement accounts

It is important to recognize the significance of retirement accounts and examine some of the nuances that prevent them from being just another product of the Internal Revenue Code.

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Individual retirement accounts (IRAs) are most often thought of as tax-deferred accounts that the government conjured up in the 1980s to encourage Americans to save for retirement. With almost $10 trillion in tax-deferred retirement accounts, $2.5 trillion of which is estimated to be held in IRAs, they have become an estate and tax planning force to be reckoned with. (1) According to the Employee Benefits Research Institute, over 90 percent of all households in America have some sort of financial account, and of those households surveyed, retirement accounts were second in popularity only to transactional accounts such as checking and savings accounts. (2) It is important to recognize the significance of these accounts and perhaps examine some of the nuances that prevent them from being just another product of the Internal Revenue Code, since it is likely under current tax law that a generous portion of the approximate $7.5 trillion that are in non-IRA retirement accounts will eventually be rolled into IRAs at some point in the future.

It is also important to recognize that every state has enacted laws that touch the world of IRA administration, that must be considered together with case law that sometimes seems to have little to do with statutes or the Internal Revenue Code. Additionally, each IRA trustee and custodian may also limit the options available to the IRA owner or beneficiary by contract. Sometimes the interaction of all of these elements can have a surprising impact on the ultimate disposition of these accounts. The focus of this article is to raise awareness of some of these elements and point out the pitfalls they present to the unwary.

Basic Goals and Challenges of Planning with IRAs

It is imperative to understand the basic rules and goals of IRAs before discussing their nuances. IRAs have always presented special estate planning challenges due to ownership restrictions. An IRA owner cannot give the IRA away intact during his or her lifetime. This has traditionally made it difficult to properly plan for use of the unified credit because the IRA can only be used to equalize the taxable estates between spouses when the IRA owner dies. The Internal Revenue Service released new proposed Treasury regulations on January 12, 2001, and new final IRA regulations on April 16, 2002 (3) (IRA rules), simplifying administration during the IRA owner's lifetime and providing new postmortem planning opportunities. With these new opportunities come an equal number of new challenges.

One must be mindful that IRAs are not taxable until monies are distributed to a beneficiary, at which time the distribution is taxed as ordinary income at the beneficiary's tax rate. The length of income tax deferral available depends on whether a beneficiary is named, and who is considered a "designated" beneficiary under the new IRA rules. This could be either an individual or a trust that is both valid under state law and is irrevocable by its own terms upon the IRA owner's death. The beneficiary must be named on the beneficiary designation form to be considered "designated." Under the new IRA rules, the post-death distribution period is based on the life expectancy of the designated beneficiary or beneficiaries (if there are separate shares) that remain as of September 30 of the year after the calendar year of the IRA owner's death. With the best-laid plans, a non-spouse beneficiary can look forward to taking IRA distributions over his or her own life expectancy. If no beneficiary has been named, the estate is named, or if there are multiple beneficiaries and one is not an individual, the IRA will be deemed to have no designated beneficiary. Death of the IRA owner after the required beginning date (RBD) without a designated beneficiary will result in deferral based on the remaining single nonrecalculated life expectancy of the decedent. (4) If the death occurred prior to the IRA owner's RBD and there was no designated beneficiary, distribution must be made by December 31 of the calendar year containing the fifth anniversary of the decedent's date of death. This certainly curtails the benefits of tax-deferred growth that might have otherwise been available.

Spouses receive special treatment under the tax code and are the only beneficiaries that can inherit IRAs or qualified plan assets and actually roll them over, or simply change the name on the account to their own. In an ideal world, having a spouse beneficiary can result in significant tax benefits because when a spouse rolls over assets, all future distribution dates revolve around the surviving spouse's date of birth, rather than that of the deceased IRA owner. These assets are subject to an unlimited marital deduction for estate tax purposes but more importantly, if the surviving spouse is younger than the decedent, there will also be a substantial opportunity for deferral of income taxes.

Also contained in the preamble of the new final regulations under the heading "Explanation of Provisions" is the following:

The period between death and the beneficiary determination date is a period during which beneficiaries can be eliminated but not replaced with a beneficiary not designated under the plan as of the date of death. In order for an individual to be a designated beneficiary, any beneficiary must be designated under the plan or named by the employee as of the date of death. This refers to the new postmortem planning opportunities that arise through the ability to disclaim, distribute, or divide the assets. A disclaimer of assets must be done in compliance with IRC [section] 2518 as well as state statute, and must generally be done within nine months of the decedent's date of death; this is not extended to the September 30 beneficiary determination deadline. Distribution must be made prior to September 30 to any beneficiary that is not a designated beneficiary in order to preserve the deferral options of the designated beneficiaries. Finally, accounts may be divided at any time after the IRA owner's death but must be divided by the December 31 deadline in order to receive separate share treatment.

If the Internal Revenue Code were the only consideration in IRA planning, the new final rules would be simpler than the prior rules, and planning with these accounts would not present such a challenge. However, as you will see in the ensuing discussion, there are many issues unrelated to the Internal Revenue Code that can play an integral role in the outcome of the IRA. This article presents many of these issues for your consideration but will focus primarily on case law, statutory law and concerns for Florida residents and their advisors.

1) Be Aware of State Statutes Affecting IRAs

Most states have a number of statutes that impact IRAs and, while the following is not meant to be an exhaustive list of all relevant statutes, it is a starting point. It is important that practitioners are aware of the relevant statutory scheme when planning with IRAs.

The Elective Share: Florida's new augmented elective share statute became effective on October 1, 2001. IRAs and qualified plans now fall under the second tier of the three-tier priority system imposed by statute. (5) A surviving spouse who is unhappy with his or her share of the decedent's estate can now elect 30 percent of the augmented estate, including IRAs. The window for filing for the elective share is the earlier of six months from receipt of notice of administration or two years from the date of death of the decedent. (6) This date is significant in light of the September 30 deadline for IRA beneficiary determination. Furthermore, new proposed treasury regulations [section] 1.401(a)(9)-4, A-1 specifically state that "the fact that...