What Happens When a Brokerage Firm Screws Up the Designated Beneficiary Form to an IRA?

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Estate Planning Attorney

A decedent maintained two individual retirement accounts (IRAs). Consistent with his overall estate plan, he named several trusts as beneficiaries for his minor children.

Later that year, the decedent’s financial advisor joined another firm. Decedent subsequently met with one of the financial advisors to facilitate the transfer of the IRA assets to the Custodian. The financial advisor provided a beneficiary designation form for Decedent’s signature that named Decedent’s estate as the sole beneficiary. Decedent signed that form and the assets of the two IRAs held by the Custodian were directly transferred to a new IRA held by a new Custodian. It has been represented that, although Decedent signed the beneficiary designation form, he merely intended to move his IRA from Custodian A to Custodian B and that he did not intend to change beneficiaries as part of this transaction.

After Decedent’s death, the trustees of the trust petitioned the State Court for a declaratory judgment that would modify the beneficiary designation for the IRA to carry out the original estate plan. Based on its finding of Decedent’s intent, the Court ordered that the beneficiaries of the IRA were consistent with Decedent’s prior beneficiary designation. A Court Order was entered retroactively as if such designation was correctly made on the date Decedent signed the beneficiary designation form.

The IRS put a “quash” on their outcome. It ruled that although the Court order changed the beneficiary of IRA X under State law, the order cannot create a “designated beneficiary” for purposes of the tax code. Courts have held that the retroactive reformation of an instrument is not effective to change the tax consequences of a completed transaction. For example, the Tax Court considered the impact of a judicial reformation of a trust agreement for tax law purposes in Estate of La Meres v. Commissioner, 98 T.C. 294 (T.C. 1992). In La Meres, a probate court order approved the post-death amendment of a trust to eliminate a provision that caused adverse estate tax results, and held that such amendment was retroactively effective as of the date of the decedent’s death. The Tax Court held that such reformation was not effective for tax purposes explaining that:

“This and other courts have generally disregarded the retroactive effect of State court decrees for Federal tax purposes. While the IRS will look to local law in order to determine the nature of the interests provided under a trust document, they 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.

Were the law otherwise there would exist considerable opportunity for “collusive” state court actions having the sole purpose of reducing federal tax liabilities. Furthermore, 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.”

In summary, because Decedent’s estate was named as the beneficiary of the IRA at the time of Decedent’s death the estate could not qualify as a “designated beneficiary” for purposes of the code. The IRA lacked a “designated beneficiary.” Because Decedent died after the required beginning date and without a “designated beneficiary,” the assets of IRA X must be paid out over the applicable distribution period (5 years).

To discuss your NJ Estate Planning matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing consultations if you are unable to come to our office.