IRAs And Estate Taxes

Under the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, the estate tax exempt amount is $5 million in 2011 and 2012, and reverts to $1 million beginning in 2013. For 2011 and 2012 only, a deceased spouse’s unused exempt amount can be transferred to the surviving spouse. This provision is known as “portability”. As an owner of a large IRA, you ought to know how you may take advantage of portability by naming your spouse as beneficiary of your IRA benefits.

Before portability, if the decedent did not have enough nonretirement assets to fully fund the credit shelter trust, there was a tradeoff between the income tax benefits of leaving the IRA to the spouse and the potential estate tax benefits of leaving some or all of the IRA to the credit shelter trust or to or in trust for the children or grandchildren.

Portability largely solves the problem. The IRA owner can name the spouse as the beneficiary of the IRA. The spouse can take the IRA, roll it over, name new beneficiaries to get a longer stretch-out, and convert to a Roth IRA, either all at once or over a number of years. Except with respect to the income and growth on the exempt amount during the spouse’s lifetime, the estate tax benefit of the credit shelter is preserved. Portability allows the IRA owner’s unused estate tax exempt amount to be transferred to the spouse.

In order to transfer the unused estate tax exempt amount to the spouse, the IRA owner’s estate must file an estate tax return and elect to transfer the unused estate tax exempt amount to the spouse. The opportunity to shelter the income and growth on the unused estate tax exempt amount during the spouse’s lifetime is lost.

Nevertheless, the ability to leave the IRA to the spouse while preserving the unused estate tax exempt amount provides a major benefit, and simplifies the planning for IRA owners with large IRAs who do not have sufficient other assets to fully fund the credit shelter trust. This situation will be more common with a $5 million estate tax exempt amount.