NONSPOUSE BENEFICIARY  RULES

The purpose of this article is to provide background on nonspouse beneficiary inherited IRA rollovers.

(1) LAW AND GUIDANCE - The Pension Protection Act of 2006 (PPA) added Code section 402(c)(11) which stated that beginning in 2007, if a participant in a retirement plan dies leaving his or her accrued benefit under the plan to a nonspouse designated beneficiary, the designated beneficiary may be able to roll over the inherited funds into an IRA set up to receive such funds. The rollover must be accomplished by a direct trustee-to-trustee transfer (a "direct rollover") and the retirement plan must provide for this type of rollover. Also the distribution must otherwise be eligible for rollover, meaning, for example, that required minimum distributions under Section 401(a)(9) cannot be rolled over.

The IRS issued Notice 2007-7 in Q & A format to provide guidance on how this transaction would actually operate. The IRS subsequently published a special edition of its online newsletter Employee Plan News,to provide further clarification of Notice 2007-7. Note: Although individuals in nontraditional relationships may establish inherited IRAs, the federal Defense Of Marriage Act denies a same-sex partner spousal status for federal tax purposes, even if applicable state law recognizes same-sex marriage or civil unions.

(2) INHERITED IRA TITLE - The IRA must be identified explicitly as an IRA with respect to a decedent. Thus the names of the decedent and the beneficiary must be included in its title. For example, an appropriate title would be "Mary Smith as beneficiary of John Smith."

(3) "DIRECT ROLLOVER" REQUIREMENTS - A direct rollover is the exclusive means of moving funds from a qualified plan to an inherited IRA. Therefore, a rollover to the beneficiary's own IRA is not permitted and a nonspouse beneficiary may not take a cash distribution and then complete a rollover within 60 days.

(4) TRUST AS BENEFICIARY - A plan may make a direct rollover to an IRA established on behalf of the beneficiary of a trust provided the beneficiary is the designated beneficiary within the meaning of the required minimum distribution rules of IRS Section 401(a)(9)(E). In this situation, the IRA must be established with the trust identified as the beneficiary and distributions made based on the life expectancy (ies) of the beneficiary (ies) of the trust.

(5) ROLLOVER NO LATER THAN 4TH YEAR AFTER DEATH - If the five-year rule (versus a life expectancy payout) applies, a direct rollover must be completed within the first four years of the five-year period but not in the fifth year. Because Required Minimum Distributions (RMDs) are calculated based on the preceding December 31 balance and receiving organizations don't track rollovers for distribution calculation until a December 31st has passed, this is a logical requirement. For example, if the funds were rolled over in the fifth year, they would not be included in an RMD calculation program because they were not in the account on the preceding December 31.

(6) INHERITED IRA TO FOLLOW PLAN DISTRIBUTION RULES - Generally, the inherited IRA must follow the distribution rules of the plan. Thus, if the plan only offers life expectancy, then the inherited IRA must make life expectancy payments (though nothing would prohibit a beneficiary from accelerating the payments). Conversely, if the plan requires distribution within five years of the death of a participant who dies before the required beginning date for an RMD, then the inherited IRA must follow the five-year rule. However, Notice 2007-7 adds a "special rule" for such situations.

"The Special Rule" - Under this rule, a nonspouse designated beneficiary may elect to use the life expectancy method instead of applying the five-year rule; however, the account must be directly rolled before the end of the year following the year of death for this to apply. In addition, the RMDs under the newly established inherited IRA in this situation must be determined using the life expectancy of the same designated beneficiary.

(7) LIFE EXPECTANCY RULE - If the life expectancy rule applies, The RMD paid by the IRA must be determined using the same applicable distribution period as would have been used by the plan had the direct rollover not occurred.

Similarly, if the participant dies on or after the required beginning date, the RMD paid by the IRA for any year after the year of death must be determined using the same applicable distribution period as would have been used had the direct rollover not occurred.

(8) PLAN AMENDMENT - In Notice 2007-7, the IRS provided guidance on the operation of these rules including that the employer plan did not have to incorporate the provision for the nonspouse beneficiary rollover as this was an optional plan provision. Later in 2007, the IRS indicated on its webpage that the nonspouse beneficiary rollover would be a required plan provision effective for plan years starting in 2008 but that for 2007 it was an optional provision. The reason cited for this change was the pending Technical Corrections Act was known to have a provision to make this a required plan provision. When finally released PPA Technical Corrections made the nonspouse beneficiary direct rollover distribution a required plan provision for plan years starting after December 31, 2009.

(9) ADDITIONAL INFORMATION - 2008 Publication 590 Information On Nonspouse Beneficiary Rollovers.

Page 26 - "Rollover by nonspouse beneficiary. A direct transfer from a deceased employee's qualified pension, profit sharing or stock bonus plan, annuity plan, tax-sheltered annuity (section 403(b)) plan, or governmental deferred compensation (section 457) plan to an IRA set up to receive the distribution on your behalf can be treated as an eligible rollover distribution if you are the designated beneficiary of the plan and not the employee's spouse. The IRA is treated as an inherited IRA.