Creating an Individual Retirement Account, or IRA, is a popular strategy for people in all tax brackets to create tax-advantaged savings, which in many cases can represent substantial assets. What happens when those assets are not clearly allocated in the holder’s estate plan?

That was the question recently presented to the California Court of Appeal (Reich v Reich).

In September of 2003, Thomas Reich created a revocable trust to provide for the distribution of his assets upon his death. The trust was amended several times, most recently in May of 2016. The final version of the plan said that his ex-wife, his brother, and a nephew were to receive a total of $1.5 million in cash, with any residue to go to his daughter Shannon or, if she died before Thomas, then to Shannon’s daughter, Leah, in separate trusts created for their benefit.

Thomas maintained an IRA at a bank. A few months after he amended his estate plan, Thomas completed a form at the bank that specified that upon his death his daughter’s and granddaughter’s trusts were each to receive half of the proceeds of his IRA.

Four years later, in November of 2020, Thomas married Pamela, described in court documents as his “longtime close acquaintance.” Thomas died less than eight months later without updating his trust or the IRA beneficiary form to provide for Pamela.

At the time of Thomas’s death, his IRA was valued at about $1.5 million.

In November of 2021, Pamela filed a probate petition with the Los Angeles Superior Court asking for an “omitted spouse’s share” of her late husband’s estate, including his IRA.

Under California law, a person whose spouse dies without having provided for them in “testamentary instruments” that predate their marriage is normally entitled to a share of the decedent’s estate as an “omitted spouse.”

The question presented to the probate court was whether the IRA, which was designated to go to two trusts as beneficiaries, should be treated as part of Thomas’s estate and thus be included in the total on which the “omitted spouse” provision would be calculated.

Pamela’s petition argued that the proceeds of the IRA were part of Thomas’s estate because the proceeds had to be “marshalled” through his trust before they could pass to the trusts of Shannon, his daughter, and Leah, his granddaughter.

Shannon, as trustee of Thomas’s estate, objected. She pointed out that the IRA proceeds would pass directly to the separate trusts for her and her daughter, and not through the trust, which put these assets outside Thomas’s estate for purposes of calculating the omitted spouse’s share.

The trial court decided in favor of Pamela, ruling that an IRA’s proceeds can sometimes be included in a decedent’s estate and that in this case the proceeds would pass to “sub-trusts” of Thomas’s trust and thus would have been part of that trust.

Pamela and the trust’s beneficiaries reached a partial settlement after the trial judge’s ruling, with the other beneficiaries agreeing to accept reduced amounts to accommodate Pamela’s omitted spouse share.

The settlement excluded the IRA proceeds, and Pamela again asked the probate court to determine whether she was entitled to a share of the assets set aside for Shannon and Leah.

A different judge heard the case, and ruled against Pamela, reasoning that the IRA proceeds were not part of Thomas’s “estate,” and thus were not subject to the omitted spouse’s share. The decision noted that the IRA proceeds constituted a “nonprobate” asset, because the IRA beneficiary designation form Thomas signed specified that the proceeds would “flow directly” to Shannon’s and Leah’s separate trusts, not through Thomas’s trust.

Pamela appealed, but without success.

The appellate justices disagreed with Pamela’s claim that the IRA proceeds passed through Thomas’s trust. While Thomas may have tried to “kill two birds with one stone” by creating the trusts for his daughter and granddaughter in his own trust document, those were still separate trusts to which the IRA proceeds flowed directly, not through his trust.

They also rejected other arguments she made related to Thomas’s possible intentions, the wording of the IRA document, and other technical issues. The justices affirmed the lower court’s ruling and awarded Shannon, as trustee of Thomas’s estate, her costs on appeal.

By Lynda I. Chung