Estate Planning Vault

New Planning Opportunities with Non-Spouse Rollovers

The Pension Protection Act of 2006 authorized beneficiaries other than surviving spouses to roll over a qualified plan to an inherited IRA. This article looks at a very recent pronouncement from the IRS that gives meaning to this provision and, therefore, is very beneficial to clients and all wealth planning professionals who understand its implications.

Non-Spouse Rollovers

Planning Tip: Before 2007, a non-spouse beneficiary was stuck taking distributions under the terms of the plan, which typically require full distribution within 5 years of the participant's death.

Planning Tip: Clients who name a trust as designated beneficiary can protect the assets from creditors (including a former spouse of the beneficiary) and spendthrift beneficiaries, who often withdraw far more than the required minimum distributions. Naming a trust also allows the participant's financial advisor to continue to manage the assets as the participant desired.

The IRS Roadblock

New, More Favorable Guidance from the IRS

Apparently in response to rumors that Congress was going to include legislation affirmatively requiring non-spouse rollovers, in late October the IRS issued its 2007 Interim and Discretionary Amendments, available here online, as follows:

Section 402(c)(11) [Discretionary]:

PPA '06...added Section 402(c)(11) to allow non-spouse beneficiaries to roll over distributions from a qualified plan to an individual retirement plan. Non-spouse beneficiary rollovers are an optional plan provision for 2007. See, Notice 2007-7.

Pursuant to an impending technical correction, non-spouse beneficiary rollovers will be required for plan years beginning on or after January 1, 2008 (emphasis added).

Planning Tip: The IRS will soon be issuing a Technical Correction that requires all qualified plans to permit non-spouse rollovers for plan years beginning on or after January 1, 2008.

What Does This Mean?

Beginning January 1, 2008, non-spouse beneficiaries will be able to take advantage of the PPA 2006 provisions and roll over a qualified plan into an Inherited IRA. With an Inherited IRA, a non-spouse beneficiary can use his or her own life expectancy to determine required minimum distributions. This significantly reduces 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.

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. This is different from a spousal rollover, where the surviving spouse can defer required minimum distributions until attaining 70 1/2.

A rollover to a non-spouse beneficiary must be directly from the trustee of the qualified plan to the trustee of the Inherited IRA (at trustee-to-trustee transfer). In addition, and unlike a spouse rollover, the IRA must remain in the name of the deceased participation.

Planning Tip: Avoid re-titling the qualified plan in the name of the non-spouse beneficiary. Also avoid transferring the qualified plan to an existing IRA in the non-spouse beneficiary's name. Both constitute a taxable distribution of the entire account. The Inherited IRA should be titled like this : Sam Participant, deceased, IRA f/b/o Emily Participant (beneficiary).

Planning Tip: Any distribution to a non-spouse beneficiary is a taxable distribution, subject to income tax. Therefore the check should be made payable directly to the Inherited IRA.

Planning Opportunities

The IRS's change of position means that all planning options are now available to non-spouse beneficiaries of qualified plans. These options include those listed below, which were outlined in greater detail in a prior article:

• 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.
• Name a Charitable Remainder Trust as beneficiary with a lifetime payout to a surviving spouse; the remaining assets pass to charity at the death of the spouse.
• Give up to $100,000 from IRAs directly to charity before December 31, 2007.

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 the qualified plan to an Inherited IRA rather than be stuck with shorter payout under the plan provisions, thus permitting the planning team to implement the right strategy to meet the client's unique planning objectives.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer's particular circumstances.