Non-Spouse Beneficiary Rollover Option No Longer Optional
When the Pension Protection Act of 2006 (PPA) was finally passed, many saw it as a welcome piece of legislation giving Americans more options and incentives to save for their retirement, including important tax benefits. One of the key pieces of the legislation gave non-spouse beneficiaries the right to rollover funds they received under a qualified retirement plan into their own IRAs.
This provision was so important because prior to the passage of the PPA, only spouse beneficiaries were permitted to rollover funds received from their deceased husband or wife's retirement account. Non-spouse beneficiaries were required to take a lump sum distribution from the account, which could have considerable tax consequences for them. Whenever money is taken from a pre-tax retirement account, taxes must be paid on the money removed from the account. Additionally, the money then is considered income for taxation purposes and potentially could move an individual into a higher tax bracket.
Under the PPA, non-spouse beneficiaries have the option of directly rolling over the funds from certain employer-sponsored qualified plans, tax-sheltered annuities and certain government plans into inherited IRAs. Non-spouse beneficiaries could include domestic partners, children, parents, friends and even trusts.
The non-spouse beneficiary provision went into effect on January 1, 2007. The problem, however, is that due to an oversight by Congress in drafting the provision, retirement plans were not required to offer direct rollovers to non-spouse beneficiaries. Instead, retirement plans had the option of offering this important benefit, which many chose not to do. This, in turn, resulted in only some non-spouse beneficiaries being able to take advantage of the PPA's benefits.
After two years of attempts, Congress finally has corrected this oversight in the Worker, Retiree and Employer Recovery Act (WRERA). Beginning on January 1, 2010, all employer-sponsored retirement plans will be required to offer direct IRA rollovers to non-spouse beneficiaries.
Key Points about Non-Spouse Beneficiary Rollovers
Some important points to remember about non-spouse beneficiary IRA rollovers:
- The rollover must be a trustee-to-trustee rollover. In other words, it must be a direct rollover. The check should be made from the qualified account to the IRA.
- The rollover must be to a new IRA. It cannot be to an existing IRA owned by the non-spouse beneficiary.
- The new IRA cannot be in the beneficiary's name. Instead, it should be in the retirement account owner's name — for example: John Smith, deceased, IRA f/b/o Jane Anderson (beneficiary).
- The total amount that may be rolled into the new IRA is less any required minimum distributions. If the account owner died before required minimum distributions had to be made (i.e., 70.5 years old), then either the five year rule or the life expectancy rule will be used to determine how much must be held out before rolling the remainder into the new IRA.
- Unless there is a stretch option, the direct rollover must occur by December 31 following the year of the retirement plan owner's death. If there is a stretch option, then the rollover can occur anytime after the plan owner's death, so long as the non-spouse beneficiary took out the required minimum deductions.
Direct Roth IRA Rollovers
Under WRERA and IRS Notice 2008-30, non-spouse beneficiaries also have the option of directly rolling over funds into a Roth IRA instead of a traditional IRA. So long as the rollover meets the technical requirements for a Roth IRA, then the same rules apply for creating the inherited Roth IRA as they do for creating the inherited IRA. For example, the inherited Roth IRA must be in the deceased retirement account owner's name and not the beneficiary's.
The option of rolling the funds over into a Roth IRA gives non-spouse beneficiaries even greater flexibility in choosing the right tools to plan for their own retirement investments.
For more information on non-spouse beneficiary direct rollovers, required minimum distributions and tax consequences, contact an experienced attorney today.