If you participate in an employer-sponsored qualified retirement plan, such as a defined benefit plan, 401(k) plan, employee stock ownership plan (ESOP), 403(b) plan, or 457(b) plan, you may have chosen a beneficiary to receive your account balance in the event of your death. If you are married, the law requires that your spouse be named the primary beneficiary of your account, unless he or she waives that right in writing. However, if you are unmarried, or your spouse has waived his or her right, you may wish to name a parent, sibling, child, domestic partner, other relative, friend, or trust as the beneficiary. As of 2010, non-spouse beneficiaries of inherited retirement plan accounts are permitted to roll over these assets into Individual Retirement Accounts (IRAs) on a tax-free basis.
The provision allowing rollovers by non-spouse beneficiaries was included in the Pension Protection Act of 2006 (PPA ‘06) and initially went into effect on January 1, 2007. Prior to this time, only the spouse of the deceased account owner was permitted to defer taxation on the account by rolling over the funds to an inherited IRA, while any non-spouse beneficiary was required to take a lump sum distribution from the account. Non-spouse beneficiaries were thereby obligated to pay taxes on the full amount received and to declare the income on their personal tax return, potentially creating a challenging tax situation. Starting in 2007, non-spouse beneficiaries were allowed to make the same tax-free rollovers as spouses.
However, under the PPA, tax-qualified employer-sponsored retirement plans were not required to offer direct rollovers to non-spouse beneficiaries. Consequently, many non-spouse beneficiaries did not have access to these tax-free rollovers, unless the plan sponsors had voluntarily chosen to provide the option.
Congress closed this gap in the Worker, Retiree and Employer Recovery Act of 2008 (WRERA), through a provision mandating employer-sponsored retirement plans to offer the rollover option to non-spouse beneficiaries in plan years beginning after December 31, 2009. The WRERA provision also stipulates that beneficiaries who do not opt for a direct rollover, and instead choose to take distributions in the form of a cash lump sum, will be subject to mandatory 20% income tax withholding rules. As a result of IRS Notice 2008-30, non-spouse beneficiaries may also choose to roll over retirement account funds into an inherited Roth IRA subject to taxation.
Under the rules, non-spouse beneficiaries are permitted to directly roll over funds inherited from employer-sponsored retirement plans into inherited IRAs. According to the IRS, retirement plan distributions to a non-spouse beneficiary are subject to many of the same rules that apply to other eligible rollover distributions. Retirement plan sponsors must offer a non-spouse beneficiary the option of making a direct rollover, or a trustee-to-trustee transfer, of eligible rollover distributions to an inherited IRA. This means the transfer is made from the retirement plan to the IRA, and not to the beneficiary.
Other restrictions apply. The rollover must be made to a new IRA, not one already owned by the non-spouse beneficiary, and the new IRA must bear the name of the deceased, not the beneficiary. The rollover must be completed by December 31 of the year following the account holder’s death. In addition, beneficiaries are not permitted to make additional contributions to the inherited IRA. The beneficiary must have the same basis in the inherited IRA as the deceased account owner, and the beneficiary may not combine the basis in the inherited IRA with the basis in his or her own IRAs.
After the rollover has occurred, the beneficiary must begin receiving distributions under the beneficiary distribution rules. The beneficiary will not owe taxes on the inherited IRA assets until he or she starts to receive distributions.
These rule changes, which provide important options to non-spouse beneficiaries of employer-sponsored qualified retirement plan accounts, apply to all retirement plans as of 2010. For more information about your employer-sponsored retirement plan, consult the benefit plan administrator at your company.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
LPL Tracking # 1-845035 (exp. 5/21)