When the Pension Protection Act of 2006 was first enacted, there was much excitement in regard to the non-spouse beneficiary rollover provision. Unfortunately, we found out that this great new provision was not mandatory. The IRS ruled that the employer sponsored retirement plan was not required to allow for a non-spouse beneficiary rollover. Congress has finally fixed this problem via a technical correction to the Pension Protection Act, but the provision won't become effective until 2010. However, starting in 2010, all named non-spouse beneficiaries will be able to take advantage of this great option. In addition, the new tax law, taken together with prior tax laws and IRS rulings, can make this non-spouse beneficiary provision even more powerful.
The original problem
The tax code states that almost all distributions from employer sponsored retirement plans are eligible for rollover; however it also states that non-spouse beneficiaries are not allowed to exercise this option. This contradiction created problems for non-spouse beneficiaries of employer plans. Subsequently, they could not take the plan balance and move it to an inherited IRA because of this prohibition on non-spouse beneficiary rollovers. A spouse beneficiary, on the other hand, is allowed to rollover the inherited plan assets to an IRA. Another problem was that most employer plans do not offer a "stretch" distribution option to non-spouse beneficiaries. Unfortunately, they were often stuck with funds in a qualified retirement plan that required accelerated distributions. They had to pay income tax on those distributions and lost the ability to stretch them out over their individual life expectancies.
To fix this problem, the Pension Protection Act of 2006 contained a provision that allowed a designated (named) non-spouse beneficiary to do a direct rollover of inherited plan assets to a properly titled inherited IRA. In Notice 2007-7 and in further announcements, the IRS interpreted this to mean that while a plan could offer the option, they were not required to do so. Unfortunately, many plans have chosen to follow this IRS interpretation. In the last two years, several bills have been introduced in Congress that contained the necessary technical correction to fix this issue, but these went nowhere. The provision is now included in the Worker, Retiree and Employer Recovery Act (WRERA), which was signed into law late last year. For company sponsored retirement plan years beginning after December 31, 2009, this provision will now be mandatory. It will apply only to designated beneficiaries, meaning that the non-spouse beneficiary must be an individual or a qualifying trust (a "see-through" trust). A trust that does not qualify cannot do the post-death rollover to an inherited IRA.
Non-spouse rollover rules
In order to use the life expectancy ("stretch") options available in an IRA when a company sponsored plan does not offer that option, a non-spouse plan beneficiary must do the direct rollover from the plan to a properly titled inherited IRA by December 31 of the year following the year of the plan participant's death. In addition, the first minimum required distribution (MRD) must also be withdrawn by that same December 31st date. A properly titled inherited IRA must retain the name of the decedent in the title. For example: "John Smith deceased, fbo Tom Smith, Beneficiary IRA". If a company sponsored plan offers its non-spouse beneficiaries a stretch distribution option, they can still transfer the inherited plan funds to an inherited IRA at any time after the plan participant's death as long as they have taken timely MRDs from the retirement plan.
2010 inherited Roth IRA opportunities
The new law, in conjunction with IRS Notice 2008-30 (issued March 5, 2008) now not only forces company sponsored plans to allow non-spouse beneficiaries to do direct rollovers to inherited IRAs, but also to inherited Roth IRAs. While the new law (WRERA) does not address non-spouse post-death Roth conversions, IRS Notice 2008-30 does. It permits this option by allowing for post-death Roth IRA conversions from company sponsored retirement plans. In essence, Notice 2008-30 created two classes of beneficiaries. IRA beneficiaries who cannot convert inherited IRAs to inherited Roth IRAs, and company sponsored retirement plan beneficiaries who can convert their inherited balances to an inherited Roth IRA. This unfairness may be addressed in future IRS guidance, but for now company sponsored qualified plan beneficiaries have a post-death Roth conversion advantage.
Are rollovers now irrelevant?
In light of this provision, some plan participants might be inclined to leave their retirement funds with the company sponsored plan, rather than doing an IRA rollover. If the IRA rollover was the right move before this law (WRERA), it is still the right move now. Leaving beneficiaries at the mercy of a company's retirement plan and or any potential tax law changes is never a good long-term planning strategy. Basically, the plan is an extension of the company. The financial market meltdown made it more evident now than ever before that individuals can no longer count on even the oldest and biggest companies to be around for the long haul. It is usually best for employees to take control of their retirement funds the minute they have access to them.
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