From the Tax Adviser: rollover IRAs and estate planning.

Most people think of individual retirement accounts as simple investments, limited to small amounts and restricted to a small group. Most believe IRAs are uncomplicated investments, with investments and deductions limited to only $2,000 each year, and even then available only if they are not covered by some other retirement plan.

However, many taxpayers are using, or are considering, rollover IRAs for large amounts of money and property that they receive from qualified retirement plans. Taxpayers in these situations should consider all the estate planning ramifications.

DEFINITION

A rollover IRA is a distribution received from an employer's qualified retirement plan that is rolled over into an IRA. ("Rollover IRA" is also sometimes used to refer to transfers from one IRA to another; this discussion will not involve IRA-to-IRA rollovers.) If a distribution is rolled over, no tax currently will be due; however, the amount rolled over will be taxable when the new plan pays out that amount to the taxpayer or beneficiary.

ROLLOVERS FROM EMPLOYER PLANS

All or part of an eligible distribution from a taxpayer's (or a deceased spouse's) qualified plan can be rolled over into an IRA.

The most that can be rolled over is the taxable part of any eligible distribution. This does not include contributions made by the taxpayer to the employer plan, unless they are voluntary deductible employee contributions.

Partial distributions. Partial distributions from qualified plans are eligible for rollover treatment as long as they are not required minimum distributions, such as amounts that must be paid out to people who have reached 70 1/2, and are not part of a series of equal periodic distributions that are to be paid annually over life, life expectancy or a period of at least 10 years.

Withholding. In general, if an eligible rollover distribution is paid directly to the taxpayer, the payer must withhold 20%; this applies even if the taxpayer intends to roll over the distribution to an IRA. However, if the employer's plan allows the option of a direct rollover, in which all or part of the distribution is paid directly to an IRA trustee, no tax will be withheld.

Property and cash received in distribution. If both property (that is, shares of stock) and cash are received in an eligible distribution, either the property, the cash or both can be rolled over. If a taxpayer receives property in a distribution, he or she must either contribute the property to the plan or sell it and roll over the sales proceeds. A taxpayer cannot keep the property and contribute its fair market value. If the distributed property is sold and the proceeds all rolled over into an IRA, no gain or loss need be recognized. The total sales proceeds, including any change in value, are treated as part of the distribution and not included in gross income.

INHERITED IRAs

In general, the entire amount in an IRA is included in a decedent's gross estate; as such, distributions are subsequently taxed to the beneficiary. In addition, an estate may be subject to tax on a deceased participant's excess retirement accumulation. At the same time, the unified credit and the marital deduction may not be available to offset this additional tax liability.

Surviving spouse. A surviving spouse who inherits an IRA can elect to treat it as his or her own (in which case the minimum distributions would be determined based on the surviving spouse's age) or may roll it over, taxfree, into his or her own IRA.

Other beneficiaries. If a designated IRA beneficiary is not the surviving spouse, he or she cannot make contributions to the IRA and cannot roll it over. However, a beneficiary will not owe tax on the assets in the IRA until distributions are received, just as if he or she were the original owner.

If the owner died after distributions had begun, any undistributed amounts must be distributed at least as quickly as under the method being used at the owner's death. If the owner died before distributions had begun, the entire interest must be distributed either by December 31 of the fifth year following the year of the decedent's death or over a period not exceeding the life expectancy of the designated beneficiary (as long as distributions begin by December 31 of the year following the year of the decedent's death).

For a discussion of IRAs and other developments, see the Tax Clinic, edited by Mitchell Stump, in the September 1995 issue of The Tax Adviser.