We have written a number of articles on the nonspouse beneficiary rollover. The latest one revisits the subject and provides a single source of up-to-date information.
Recap of the Nonspouse Beneficiary Rollover Rules
Guidance on this topic has evolved since the enactment of the Pension Protection Act of 2006 (PPA). The purpose of this article is to provide all the rules on nonspouse beneficiary rollovers in one place. To start, we provide a list of the guidance on this subject incorporated into this article.
The guidance provided has been Section 829 of the PPA that created the ability of a nonspouse beneficiary of a participant in a qualified plan, §403(b) arrangement, or governmental §457(b) plan to make a direct rollover of the deceased participant’s plan balance to an inherited IRA (effective for distributions that occur after December 31, 2006).
The IRS issued Notice 2007-7 in Q&A format to provide initial guidance. The IRS subsequently published a special edition of its online newsletter, Employee Plan News, to provide further clarification of Notice 2007-7.
MHC Comment: Individuals in nontraditional relationships may establish inherited IRAs, the federal Defense of Marriage Act denies a same-sex partner spousal status for federal tax purposes, even if applicable state law recognizes same-sex marriages or civil unions.
Inherited IRA Title
The IRA must be identified explicitly as an IRA with respect to a decedent. Thus, the names of the decedent and the beneficiary must be included in its title. For example, an appropriate title would be, “Robert Smith as beneficiary of John Smith.”
Direct Rollover Requirements
A direct rollover is the exclusive means of moving funds from a qualified plan to an inherited IRA. Therefore, a rollover to the beneficiary’s own IRA is not permitted, and a nonspouse beneficiary may not take a cash distribution and then complete a rollover within 60 days. We assume the rationale for this is to prevent mistakes or abuse and to avoid invalidation of the rollover.
Nonspousal direct rollovers are exempt from the standard direct rollover requirements, including the mandatory 20% withholding on amounts not directly rolled over and the requirement to provide the 402(f) rollover notice. Nonetheless, the IRS recommends providing a 402(f) notice.
A plan previously was not required to offer a direct rollover of a distribution to a nonspouse beneficiary. However, if the plan does contain such a provision, then the opportunity to make a direct rollover will be considered a benefit, right, or feature subject to §401(a)(4) nondiscriminatory rules. The nonspouse rollover becomes a required provision in 2008 plan operation.
Terminating Plans Must Offer Nonspouse Beneficiary Direct Rollovers
A terminating defined contribution plan must offer direct rollovers to nonspouse beneficiaries regardless of existing plan terms. The DOL recently issued separate guidance on this and on the use of nonspouse inherited IRAs by orphan plans.
Trust as Beneficiary
A plan may make a direct rollover to an IRA established on behalf of a beneficiary of a trust provided the beneficiary is a designated beneficiary within the meaning of the required minimum distribution rules of §401(a)(9)(E). In this situation, the IRA must be established with the trust identified as the beneficiary and distributions made based on the life expectancy(ies) of the beneficiary(ies) of the trust.
Rollover No Later Than 4th Year after Death
If the five-year rule (versus a life expectancy payout) applies, a direct rollover must be completed within the first four years of the five-year period but not in the fifth year. Because RMDs are calculated based on the preceding December 31 balance, and receiving organizations don’t track rollovers for distribution calculation purposes until a December 31st has passed, this is a logical requirement. For example, if the funds were rolled over in the fifth year, they would not be included in an RMD calculation program because they were not in the account on the preceding December 31.
Inherited IRA To Follow Plan Distribution Rules
Generally, the inherited IRA must follow the distribution rules of the plan. Thus, if the plan only offers life expectancy payments, then the inherited IRA must make life expectancy payments (though nothing would prohibit a beneficiary from accelerating the payments). Conversely, if the plan requires distribution within five years of the death of a participant who dies before the required beginning date, then the inherited IRA must follow the five-year rule. However, Notice 2007-7 adds a “special rule” for such situations.
The Special Rule
Under the special rule, a nonspouse designated beneficiary may elect to use the life expectancy method instead of applying the five-year rule; however, the account must be directly rolled before the end of the year following the year of death for this to apply. In addition, the RMDs under the newly established inherited IRA in this situation must be determined using the life expectancy of the same designated beneficiary.
Life Expectancy Rule
If the life expectancy rule applies, the RMD paid by the IRA must be determined using the same applicable distribution period as would have been used by the plan had the direct rollover not occurred.
Similarly, if the participant dies on or after the required beginning date, the RMD paid by the IRA for any year after the year of death must be determined using the same applicable distribution period as would have been used had the direct rollover not occurred.
Nonspouse Beneficiary of a Participant Who Died Prior to 2006
An IRS representative clarified that the special rule, which permits a beneficiary in a plan with only the five-year rule to nonetheless choose the life expectancy method of distribution once the funds are directly rolled into the inherited IRA [Notice 2007-7 Q&A 17(c)], is not available for beneficiaries of participants who died before 2006.
This option was not made available because the deadline for a beneficiary to choose the life expectancy method is the end of the year after the participant’s death; thus, the deadline to choose the life expectancy method for a participant who died before 2006 has already passed.
However, the IRS representative confirmed that a beneficiary who is taking life expectancy payments for a participant who died prior to 2006 may still directly roll the remaining amount, less the RMD for the year of the direct rollover, to an inherited IRA. (This is possible only if the plan permits direct rollovers by non-spouse beneficiaries to inherited IRAs.)
Further, it was confirmed that a beneficiary of a participant who died in 2004, 2005, or 2006 in a plan with the five-year rule, may directly roll the remaining amount to an inherited IRA and continue the five-year rule (assuming the plan permits direct rollovers by nonspouse beneficiaries to inherited IRAs and the rollover is completed within the first four years after the participant’s death).
Keep in mind that for 2007, the nonspouse direct rollover was an employer option and was signified by the employer board resolution. For 2008, the nonspouse direct rollover is required in plan operation.This is explained below.
Plan Amendment
PPA does not require any plan amendment to be made until the 2009 plan year. A sponsor does not have to amend its plan to offer the nonspouse beneficiary rollover. However, a board resolution would be the appropriate way for the employer to document both the option’s availability and the date it became available. In the summer of 2007, the IRS placed on its website a plan amendments page. On it there was mention of the nonspouse beneficiary rollover being a required PPA plan document provision for 2008, rather than an employer option. In Notice 2007-7 the IRS had made it clear that this was an optional plan provision that the employer could include or exclude in the document. The IRS stated that for 2007, it remains an optional provision. A link to the web page is provided below as well as the paragraph on that page dealing with this.
http://www.irs.gov/retirement/article/0,,id=173372,00.html
§ 402(c)(11) [Discretionary]: PPA ’06 § 829(a)(1) added § 402(c)(11) to allow nonspouse beneficiaries to roll over distributions from a qualified plan to an individual retirement plan. Nonspouse beneficiary rollovers are an optional plan provision for 2007. See, Notice 2007-7. Pursuant to an impending technical correction, nonspouse beneficiary rollovers will be required for plan years beginning on or after January 1, 2008. See, section 9(e) of S. 1974, the Pension Protection Technical Corrections Act of 2007, as introduced in the Senate on August 2, 2007 and section 9(e) of H.R. 3361, the Pension Protection Technical Corrections Act of 2007, as introduced in the House of Representatives on August 3, 2007.
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Bill Grossman, QPA |
