Before 2007, a non-spouse beneficiary of a
qualified plan was stuck taking distributions
under the terms of the plan, which typically
required full distribution within five or
fewer years of the participant's death. The
Pension Protection Act of 2006 (PPA 2006)
authorized non-spouse beneficiaries (before
it was only surviving spouses) to roll over
to an Inherited IRA.
This issue of my newsletter looks at a very
recent pronouncement from the IRS that
finally makes this PPA 2006 provision useable
and, therefore, is very beneficial to clients
and all wealth planning professionals who
understand its implications.
Apparent Good News in PPA 2006
PPA 2006 provides that, effective January 1,
2007, a non-spouse qualified plan beneficiary
may be permitted to roll over to an Inherited
IRA after the plan participant's death.
The January 2007 IRS Roadblock
Unfortunately, the IRS focused on the "may"
and quickly issued guidance that virtually
eliminated the planning opportunity that PPA
2006 seemed to provide. In its January 29,
2007 Notice 2007-7, the IRS declared that a
plan was not required to offer non-spouse
rollovers, saying it was optional with the
plan provider whether to adopt a plan
amendment permitting non-spouse rollovers.
Therefore, absent a voluntary plan amendment,
a non-spouse was stuck using the plan's
payout period. And major plan providers did
not offer such amendments to their prototype
plans.
The October 2007 IRS Roadblock Removal
In late October the IRS issued its 2007
Interim and Discretionary Amendments, as follows:
"Section 402(c)(11) [Discretionary]:
PPA '06 . . . added Section 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." (Emphasis added.)
This amendment appears to be in anticipation
of a Congressional change to PPA 2006 to make
it mandatory that qualified plans permit
non-spouse rollovers. The full text of the
IRS document is at
www.irs.gov/retirement/article/0,,id=173372,00.html.
What Does All This Mean for Your Clients?
Beginning January 1, 2008, non-spouse
beneficiaries finally will be able to take
advantage of the PPA 2006 provisions and roll
over from a qualified plan into an Inherited
IRA. In the Inherited IRA, the non-spouse
beneficiary can use his or her own life
expectancy to determine annual required
minimum distributions (RMDs). This can
significantly reduce the amount that the
beneficiary must withdraw each year, thereby
deferring income tax and allowing the account
balance to continue to grow income tax free.
Implementation of a non-spouse rollover
raises numerous pitfalls for the unwary.
These pitfalls are identified in the Planning
Tips that follow.
Planning Tip: The transfer must be DIRECTLY
from the plan Trustee to the Inherited IRA's
Custodian or Trustee.
Planning Tip: Any distribution to a
non-spouse beneficiary is a taxable
distribution, subject to income tax.
Therefore any check delivered by the plan
Trustee MUST be made payable directly to the
Inherited IRA Custodian or Trustee.
Planning Tip: Unlike with a surviving spouse
rollover, the Inherited IRA must remain in
the name of the deceased participant. The
Inherited IRA should be titled like this:
Account Holder, deceased, IRA f/b/o Beneficiary.
Planning Tip: DO NOT re-title the qualified
plan in the name of the non-spouse
beneficiary. That will be treated as a
taxable distribution.
Planning Tip: DO NOT transfer from the
qualified plan to an existing IRA in the
non-spouse beneficiary's name. That, too,
constitutes a taxable distribution of the
entire account.
Planning Tip: A non-spouse beneficiary must
begin taking required minimum distributions
from the Inherited IRA by December 31 of the
year following the year of the participant's
death. Note: This is different from a spouse
rollover, where the surviving spouse can
defer required minimum distributions until
attaining age 70 1/2.
Planning Opportunities
The IRS's change of position means that
additional planning options are now available
for non-spouse beneficiaries of qualified
plans. These options include those listed
below, which were outlined in greater detail
in a prior issue of The Wealth Counselor:
* Name a Retirement Trust as beneficiary
to ensure the longest term payout possible,
while also ensuring consistent account
management - in the manner desired by the
client using the client's advisors -
oftentimes over generations.
* Give the accounts to charity at death
and replace with insurance owned by a Wealth
Replacement Trust.
* Take the money out during lifetime and
buy an immediate annuity to provide a
guaranteed annual income, to pay the income
tax, and to pay for Insurance owned by a
Wealth Replacement Trust.
* Take the money out during lifetime and
pay the income tax, then gift the remaining
cash through an Irrevocable Life Insurance
Trust or other Irrevocable Trust.
* Name a Charitable Remainder Trust as
beneficiary with a lifetime payout to a
surviving spouse; the remaining assets
passing to charity at the death of the spouse.
* Give up to $100,000 from IRAs directly
to charity before December 31, 2007.
Asset Management Opportunities
Experience teaches that beneficiaries often
frustrate the stretch-out plans of the
decedent and squander their opportunity for
tax-free growth by withdrawing far more than
the required minimum distributions. However,
if the participant names a trust as
beneficiary of the qualified plan, PPA 2006
provides that the trustee of that trust may
roll over from the qualified plan into an
Inherited IRA for the benefit of the trust
beneficiary. Clients who name a trust as
beneficiary of their qualified plan account
can thereby protect the assets from creditors
(including loss in a beneficiary's divorce)
and the beneficiary from the temptation to be
a spendthrift.
Planning Tip: Naming a trust as beneficiary
also allows the participant's trusted
financial advisor to continue to manage
assets as the participant desired.
Conclusion
The IRS now requires that all qualified plans
permit non-spouse rollovers for plan years
beginning on or after January 1, 2008. This
"about face" means that all non-spouse
beneficiaries will be able to roll over from
qualified plans to Inherited IRAs rather than
be stuck with shorter payout under the plan
provisions. This will permit the planning
team to implement the right strategy to meet
the client's unique planning objectives.
