IRS Further Clarifies New Beneficiary Rollover Rules
By Robert J. Lowe,
Esq.
Mitchell Silberberg & Knupp LLP, Los Angeles, CA
The IRS has responded to some of the negative reaction it received
with respect to recently issued guidance (Notice 2007-7, 2007-5 I.R.B.
395) on the new rules allowing non-spouse beneficiaries to make
rollovers to IRAs, which were described in a recent commentary
(“Rollovers to IRAs Now Possible for Plan
Beneficiaries”).
The criticisms and the IRS response relate to two issues:
(1)
Was the statute, when originally enacted last year, intended to
guarantee all non-spouse beneficiaries the right to make an IRA
rollover regardless of the provisions of the distributing plan?
(2)
Do non-spouse beneficiaries who make a rollover to an IRA have the
right to stretch out distributions over the beneficiary's life
expectancy, even if the distributing plan would not have provided this
right.
Rollover Rights
On the first issue, the IRS stated in the issue of Employee Plans
News issued February 13, 2007,
(http://www.irs.gov/pub/irs-tege/se_021307.pdf) that “a plan
may, but is not required to” offer a direct rollover option to
non-spouse beneficiaries. This means that there is no guaranteed right
of a non-spouse beneficiary to make a rollover.
This is consistent with the IRS previously stated position that the
distributing plan must be amended to provide for rollovers by
non-spouse beneficiaries and that the amendment was optional, not
mandatory. This is not surprising since these rules were not made a
requirement for plan qualification and since all direct rollover
provisions have to be set forth in the plan document. It seems likely
that nearly all plans will eventually make this amendment, since it
costs the plan sponsor nothing and will significantly help certain
participants. However, there is no guarantee. In addition, the
amendment presumably can be made up until the deadline for plan
amendments due for the Pension Protection Act of 2006 (currently 2009
and subject to IRS extension) and be made retroactive to January 1,
2007.
Minimum Distributions
The second issue involved a provision of the original IRS guidance
that says:
The
rules for determining the required minimum distributions under the
plan with respect to the non-spouse beneficiary also apply under the
IRA. Thus, if the employee dies before his or her required beginning
date and the 5-year rule in §401(a)(9)(B)(ii) applied to the
non-spouse designated beneficiary under the plan making the direct
rollover, the 5-year rule applies for purposes of determining required
minimum distributions under the IRA.”
This provision appeared to mean that if the decedent died before
April 1 of the calendar year following the year in which he or she
attained age 701/2 and the distributing plan required minimum
distributions to be completed within five years of the death of the
participant, this rule must also apply to the recipient IRA.
The IRS has now stated that the provision quoted above should not
be read this way. Instead, the IRS is now making it clear that a
non-spouse beneficiary can use the life expectancy payout in the
recipient IRA provided that the rollover from the distributing plan
is made no later than the last day of the year following the year in
which the participant died.
Background: The Internal Revenue Code provides two methods
for satisfying minimum distribution rules when the participant dies
prior to beginning minimum distributions: (1) pay out within five
years of death (the “five-year rule”); or (2) pay out
annually over the life expectancy of the beneficiary (the “life
expectancy rule”). The plan sponsor can choose either approach
in the plan document or leave it to the beneficiary to elect.
Under the life expectancy rule, distributions must begin to the
beneficiary prior to the last day of the year following the year in
which the participant dies, whereas under the five-year rule
distributions can be made at any time until the last day of the fifth
calendar year following the year in which the participant died. What
the IRS is prohibiting, however, is a beneficiary attempting to use
the five-year rule to delay distributions under the distributing plan,
making a rollover within the five-year period and then using the life
expectancy rule under the recipient IRA.
What all this means for non-spouse beneficiaries (and their
advisors) who want to be able to stretch out distributions in a
rollover IRA is that if they wait too long to make the rollover they
may lose the opportunity to use the life expectancy rule in their
rollover IRA.
Here is how the minimum distribution rules work in different
scenarios that can occur if a participant dies before the date on
which the participant is required to begin minimum distributions and
the distributing plan permits non-spouse beneficiaries to make a
rollover:
Scenario 1: If the rollover is completed before the end of
the year in which the death occurs, the entire account balance in the
distributing plan may be rolled over and the participant may use the
life expectancy rule in the recipient IRA regardless of the
distributing plan minimum distribution provisions.
Scenario 2: If the rollover is completed during the calendar
year following the year in which the death occurs, the minimum
distribution for that calendar year may not be rolled over, but the
balance may be rolled over to an IRA and the participant may apply the
life expectancy rule in the recipient IRA with respect to the amount
rolled over.
Scenario 3: If the rollover is completed after the end of
the calendar year following the year in which the death occurred, but
prior to end of the fifth calendar year following the year in which
the death occurred, a rollover could still occur but the participant
would be required to make minimum distributions from the recipient IRA
under the five-year rule and all amounts would have to be distributed
from the IRA by the end of that fifth calendar year.
Scenario 4: If a rollover is not completed by the end of the
fifth calendar year following the year in which the death occurred, no
rollover will be possible.
For more information, in the Tax Management Portfolios, see
Kennedy, 355 T.M., IRAs, SEPs and SIMPLEs, and in Tax Practice
Series, see ¶5610, IRAs.
|
