Rollovers by Nonspousal Beneficiaries
Prior to the Pension Protection Act of 2006, a nonspousal beneficiary of a 401(k) plan could not roll over an inherited 401 (k) plan into his or her own IRA or otherwise defer income recognition if the plan mandated an immediate income distribution to the beneficiary. In many cases the result would be that the nonspousal beneficiary had to recognize significant income shortly after the death of the account owner because there was no way for a nonspousal beneficiary to defer immediate income recognition from the inherited 401 (k) plan. A spousal beneficiary has long been able to roll over the deceased spouse’s 401(k) plan into his or her own IRA and thus defer immediate taxation, even if the plan required that the account balance be distributed in a lump sum to the participant’s designated beneficiary in the year of death, or within a short period of time following the employee’s death. Effective for distributions made after Dec. 31, 2006, nonspousal beneficiaries may transfer any portion of a deceased employee’s eligible retirement plan to an IRA established for the purpose of receiving the distribution on behalf of the employee’s designated beneficiary. Such an IRA is treated as an inherited IRA, and benefits must be distributed in accordance with the RMD rules that apply to inherited IRAs of nonspousal beneficiaries. Spouses can roll over inherited 401 (k) plans into their existing IRAs, but nonspousals must establish a separate IRA the “inherited IRA.” Nonspousal beneficiaries who transfer the money to an existing IRA are liable for tax on the entire 401 (k) distribution.
Internal Revenue Bulletin: 2007 5
IRB 2007 5 provides guidance with respect to nonspousal designated beneficiaries, which includes the following questions and answers:
Can a qualified plan offer a direct rollover of a distribution to a nonspousal beneficiary?
Yes. A qualified plan can offer a direct rollover of a distribution to a nonspousal beneficiary who is a designated beneficiary, provided that the distributed amount satisfies all the requirements to be an eligible rollover distribution other than the requirement that the distribution be made to the participant or the participant’s spouse. The direct rollover must be made to an IRA established on behalf of the designated beneficiary that will be treated as an inherited IRA. If a nonspousal beneficiary elects a direct rollover, the amount directly rolled over is not includible in gross income in the year of the distribution.
How must the IRA be established and titled?
The IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.” The name of the deceased IRA owner should be included in the title, along with an indication that the IRA is for the benefit of the person who inherited it. Another recommended format is as follows: John Smith, IRA (deceased on June 11, 2007) F/B/O John Smith Jr., beneficiary.
Is a plan required to offer a direct rollover of a distribution to a nonspousal beneficiary pursuant to Section 402(c)(11)?
No. A plan is not required to offer a direct rollover of a distribution to a nonspousal beneficiary. If a plan does offer direct rollovers to nonspousal beneficiaries of some, but not all, participants, such rollovers must be offered on a nondiscriminatory basis.
If the named beneficiary of a decedent is a trust, is a plan permitted to make a direct rollover to an IRA established with the trust as beneficiary?
Yes. A plan may make a direct rollover to an IRA on behalf of a trust where the trust is the named beneficiary of a decedent, provided the beneficiaries of the trust meet the requirements to be designated beneficiaries within the meaning of Section 401(a)(9)(E). The trust must be identified as the beneficiary and the beneficiaries of the trust are treated as having been designated as beneficiaries of the decedent for purposes of determining the distribution period.
How is the RMD (an amount not eligible for rollover) determined with respect to a nonspousal beneficiary if the employee dies before his or her required beginning date within the meaning of Section 401(a)(9)(C)?
If the employee dies before his or her required beginning date, the required minimum distributions for purposes of determining the amount eligible for rollover with respect to a nonspousal beneficiary are determined under either the five year rule or the life expectancy rule.
How is the required minimum distribution with respect to a nonspousal beneficiary determined if the employee dies on or after his or her required beginning date?
If an employee dies on or after his or her required beginning date, for the year of the employee’s death, the required minimum distribution not eligible for rollover is the same as the amount that would have applied if the employee were still alive and elected the direct rollover. For the year after the year of the employee’s death and subsequent years, Q&A 5 of Regulation Section 1.401(a)(9) 5 can be used to determine the applicable distribution period to use in calculating the required minimum distribution. As in the case of death before the employee’s required beginning date, the amount not eligible for rollover includes all undistributed required minimum distributions for the year in which the direct rollover occurs and any prior year, including years before the employee’s death.
After a direct rollover by a nonspousal beneficiary, how is the required minimum distribution determined with respect to the IRA to which the rollover contribution is made?
An IRA established to receive a direct rollover on behalf of a nonspousal designated beneficiary is treated as an inherited IRA, and the rules for determining the required Minimum distributions under the plan with respect to the nonspousal beneficiary also apply under the IRA. Thus, if the employee dies before his or her required beginning date and the five year rule applied to the nonspousal designated beneficiary under the plan making the direct rollover, the five year rule applies for purposes of determining required minimum distributions under the IRA.
If the life expectancy rule applied to the nonspousal designated beneficiary under the plan, the required minimum distribution under the IRA must be determined using the same applicable distribution period as would have been used under the plan if the direct rollover had not occurred. Similarly, if the employee dies on or after his or her required beginning date, the required minimum distribution under the IRA for any year after the year of death must be determined using the same applicable distribution period as would have been used under the plan if the direct rollover had not occurred.
ALWAYS CONSULT YOUR TAX ADVISOR.