Beneficiary Rollover Inherited IRAs
Rev. 03/09/07, E-mail Alert 2007-3

Click here for an updated article on nonspouse beneficiary rollovers.

The Nonspouse Beneficiary Rollover Rules
The Pension Protection Act of 2006 (PPA) permits the 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. This new provision is effective for distributions that occur after December 31, 2006. The IRS issued initial administrative guidance for this law change in Q&A format in Notice 2007-7. (You may click here for our article on Notice 2007-7.) To further clarify the guidance, the IRS subsequently published a special edition of its online newsletter, Employee Plan News .

MHC Comment : Although individuals in nontraditional relationships may establish inherited IRAs, the federal Defense of Marriage Act does not provide a same-sex partner with the status of a spouse for federal tax purposes even if applicable state family law recognizes a same-sex marriage or a civil union.

IRS Clarifications
Although Notice 2007- 7 provided that distributions from the inherited IRA had to conform with the required minimum distribution (RMD) elections under the plan document, it also introduced the “special rule” which permits nonspouse beneficiaries who are subject to the five-year rule to shift to the life expectancy method. To do this, the life expectancy option must be chosen before the end of the year following the participant's death. The IRS issued a special edition of its Employee Plans News on February 13, 2007, to clarify this special rule.

Other Rules Introduced in Notice 2007-7

1. Direct Rollover Requirement
   The funds must be moved to the inherited IRA exclusively by a direct rollover (from the qualified plan directly to the inherited IRA). The nonspouse beneficiary does not have the option to take a cash distribution and complete the rollover within 60 days. We presume the rationale for this procedure is to prevent mistakes or abuse and to avoid invalidation of the rollover.
   
   Nonspousal direct rollovers are exempt from the usual direct rollover requirements such as mandatory 20% withholding on amounts not directly rolled over and the requirement to provide the 402(f) rollover notice. Further, plans are not required to offer nonspouse beneficiary direct rollovers.
   
2. 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.
3. Rollover No Later Than 4th Year After Death
   These rollovers must be completed within the first four years of the five-year period and 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 only rolled over in the fifth year, these funds would not be included in a RMD calculation program because they were not in the account on the preceding December 31.