Possible solution to Per Stirpes vs. Pro Rata dilemma

Last month we addressed a potential problem if you as the IRA Owner wanted to use the Per Stirpes method but were not allowed to or you used the Pro Rata Method. To review, here was the problem.

The husband and wife each named each other as primary beneficiaries and their three children as Contingent Beneficiaries. One spouse dies and nothing is changed on the IRA beneficiary election so the three children become the primary beneficiaries for the surviving spouse’s IRA, which likely also now includes the deceased spouse’s IRA.

Child #1 then dies, leaving two children as the sole primary beneficiaries under the Pro Rata Method. The surviving parent now dies.  Each surviving child receives one-half of the deceased parent’s IRA. Nothing is reserved for the family or estate of the already deceased Child #1.

The surviving children know that it was not the intent of their parents to leave nothing to Child #1. So what can they do?

They could each take their share and give a portion to the heirs of Child #1, but the distributions from the IRA would be taxed to the surviving children, not the heirs of Child #1. So that’s not the best solution and gift  tax might also be possible.

About the only other thing they can do is to use a Disclaimer. This is a legal process that essentially takes you off the beneficiary election form. They can not redirect where the funds should go, they just remove themselves from the beneficiary election form. In this case, if both surviving children execute a disclaimer and there are no other beneficiaries listed, the IRA funds would then go to the default beneficiary of the IRA Plan Agreement and Disclosure Statement, usually the deceased IRA Owner’s estate. Then, as long as the estate is set up to divide the IRA equally between the children and/or their heirs and issues, the IRA will get split up into three shares. One-third share each to the surviving children and one-third share to the heirs and issues of the deceased sibling.

Because there also could be state law defaults you want to make sure to review this with your own legal counsel. Better still, this should be reviewed BEFORE you name beneficiaries.