Retirement Benefits Planning Update
Retirement Benefits Planning Update Editor: Harvey B. Wallace II, Berry Moorman PC, The Buhl Building, 535 Griswold Avenue, Suite 1900, Detroit, MI 48228–3679, firstname.lastname@example.org.
Retirement Benefits Planning Update provides information on developments in the field of retirement benefits law. The editors of Probate & Property welcome information and suggestions from readers.
Nonspouse Inherited IRAs Revisited
In Notice 2007-7, 2007-5 I.R.B. 395, several immediately effective provisions of the Pension Protection Act of 2006, Pub. L. No. 109-80, 120 Stat. 780, are amplified. For new Code § 402(c)(11), which generally permits a designated beneficiary of a deceased qualified plan participant who is not the participant’s spouse to transfer plan benefits by direct (trustee-to-trustee) rollover to an inherited IRA, Notice 2007-7 seems at first glance to produce more questions than answers by narrowly construing what appeared to be a Code provision intended to provide nonspouse designated beneficiaries relief from the immediate income taxation of plan benefits otherwise distributable as a lump sum.
First, in Q&A-14, the Notice concludes that, except in the case of a distribution from a terminated defined contribution plan (which will be considered to offer direct rollovers to nonspouse beneficiaries without reference to the plan’s actual terms), a plan is not required to offer a direct rollover of a distribution to a nonspouse beneficiary. It is true that new Code
§ 402(c)(12) merely states that, if a trustee-to-trustee transfer from an eligible retirement plan to an inherited IRA is made, the transfer will be an eligible rollover distribution for the purposes of “this subsection.” Unlike Code § 401(a)(31), to which Q&A-14 refers regarding the procedure for making a direct transfer, Code
§ 402(c)(12) does not expressly require the plan to provide that a distributee receive a distribution in the form of a direct rollover if the distributee so elects. But, because the direct rollover procedure is mandated for plan participants and spouses who are beneficiaries, applying the procedure to nonspouse beneficiaries is a minimal administrative burden.
Can a plan offer a direct rollover of a distribution to a nonspouse beneficiary’s inherited IRA without adopting a plan amendment authorizing such a distribution? Notice Q&A-12, which states that a plan can offer a direct rollover, implies that no amendment is required, but many plan administrators may refuse to honor a designated nonspouse beneficiary’s request for a direct rollover without express plan authorization. Q&A-11 does emphasize that the distributed amount (which under Code § 402(c)(9)(A)(i) is to be “treated as an eligible rollover distribution”) must actually satisfy the requirements to be an eligible rollover distribution other than the requirement that the distribution be made to the plan participant or a surviving spouse. The term “eligible rollover distribution” is generally defined in Code § 402(c)(4) to include any distribution of all or a portion of the balance to the credit of an employee in a qualified trust except a distribution that is (1) one of a series of substantially equal periodic payments, (2) a minimum required distribution under Code § 401(a)(9), (3) a hardship distribution, or (4) any qualified disaster-relief distribution.
Overview of Minimum Required Distributions for Nonspouse Beneficiaries
The exclusion of minimum required distributions from eligible rollover treatment is discussed in the Notice in Q&A-17 (if the participant dies before the required beginning date) and Q&A-18 (if the participant dies after the required beginning date). The discussion in Q&A-17 has fortunately been supplemented in a February 13, 2007, Special Edition of Employee Plans News published on the IRS web site. As noted in the January/February 2007 Retirement Benefits Planning Update column, a primary motivation for a nonspouse designated beneficiary to request a direct rollover from a qualified plan to an inherited IRA is to avoid having to receive benefits under the accelerated distribution method otherwise required by the distributing qualified plan such as a lump-sum distribution or installment payments over a limited number of years. As long as an accelerated distribution results in at least the amount of the minimum required distribution for the year of payment being distributed, a plan may provide for any method of distribution. Even if the plan provides for distributions over the life expectancy of the nonspouse beneficiary, the direct rollover to an inherited IRA may still be desired by the nonspouse beneficiary to obtain greater control over the investment of the benefit fund or to control the ultimate disposition of the benefits on the nonspouse beneficiary’s death.
In the case of an IRA or plan that permits distributions to be made over the life expectancy periods determined under the Regulations and that does not adopt an “optional provision” under Treas. Reg. § 1.401(a)(9)-3, Q&A-4 for pre-required beginning date deaths, the Code § 401(a)(9) rules for minimum required distributions to nonspouse designated beneficiaries are straight-forward.
• If the plan participant dies after the required beginning date (RBD), benefits must be payable over a period equal to the longer of (1) the designated beneficiary’s life expectancy determined in the year following the participant’s death or (2) the participant’s remaining life expectancy determined in the year of death, in either case, reduced by one year for each year after the year of determination.
• If the participant dies before the required beginning date, benefits must be payable over the designated beneficiary’s life expectancy determined in the year following the participant’s death, reduced by one year for each year thereafter.
Under either a qualified plan or an IRA, if an employee or account owner who dies before the required beginning date with no designated beneficiary, the five-year rule applies and the account must be distributed, in full, by the end of the fifth calendar year following the year of the participant’s death.
Optional Plan Provisions—The Mandatory Five-year Rule
Under the final 2002 Treasury Regulations issued for Code § 401(a)(9), a plan may require that the five-year rule apply to certain (or all) distributions made after the participant’s death before the required beginning date, regardless of whether the participant has a designated beneficiary. Alternatively, a plan may permit the participant or a designated beneficiary to elect whether the five-year rule or the life expectancy rule will apply, provided that the life expectancy payment method must be elected before the end of the calendar year following the participant’s death. Treas. Reg.
§ 1.401(a)(9)-3, Q&A-4(b) and (c). If a qualified plan mandates payment under the five-year rule under Code
§ 401(a)(9)(B)(ii), the designated beneficiary may receive a lump-sum distribution or may be able to spread the payments over the five-year period if the plan permits, but no distribution needs to be made until the fifth year to meet the five-year rule. Q&A-19 of the Notice describes how minimum required distributions are to be made from the inherited IRA to which the direct rollover is made and states that the rules for determining minimum required distributions to the nonspouse beneficiary under the qualified plan from which the direct rollover is transferred (including the five-year rule, if applicable) are to apply to the inherited IRA as well.
Special Rule Trumps General Rule
Q&A-17 of the Notice describes the minimum required distributions that are not eligible for direct rollover under the foregoing life expectancy and five-year rules that apply to qualified plans if the participant dies before the RBD. If the life expectancy rule applies under the distributing plan, the same rule applies whether the plan participant dies before or after the required beginning date—the amount in excess of the current year’s minimum required distribution (and any prior year minimum required distributions not made) may be transferred by direct rollover to the inherited IRA. If the five-year rule applies under the distributing plan, the general rule is that a direct rollover of the total account balance may be made in any of the first four calendar years following the year of the participant’s death, but no rollover may occur at any time in the fifth year. If the direct rollover occurs in the second, third, or fourth calendar year following the participant’s year of death, Q&A-17 states that the five-year rule also must apply to the transferee inherited IRA. Under the “special rule” of paragraph (c)(2) of Q&A-17, however, the nonspouse designated beneficiary may determine the minimum required distribution under the plan using the life expectancy rule in the case of a distribution made before the end of the year following the participant’s death, provided that the transferee inherited IRA also uses the life expectancy rule using the same designated beneficiary. Though not expressly stated, the above proviso suggests that a direct rollover of the remainder of the account balance made on or before the end of the calendar year following the year of the participant’s death allows the inherited IRA to ignore the five-year rule.
Although Q&A-19, describing distributions to be made from the inherited IRA, does not state that the special rule of Q&A-17(c)(2) is intended to be an exception that permits an inherited IRA to ignore the five-year rule in the case of a direct rollover made on or before the end of the year following the participant’s death, the Employee Plans News special edition quotes Marty Pippins, manager, EP Technical Guidance and Quality Assurance, who stated: “The general rule of Q&A-19 was not intended to override the special rule of Q&A-17.” As a result, under the special rule as the Employee Plans News explanation describes it, “despite a plan provision for the 5-year rule, the nonspouse designated beneficiary is permitted to treat the plan as using the life expectancy rule both for determining the amount eligible for rollover and for determining the required minimum distributions under the IRA . . . .” Accordingly, if the distributing plan makes a minimum required distribution for the year following the participant’s death and the balance of the account to the credit of the participant is transferred (in the year following the participant’s death) by direct rollover to the inherited IRA, minimum required distributions made from the inherited IRA for the second and subsequent years following the year of the participant’s death may continue to be made using the life expectancy method.
Inherited IRA with Trust Beneficiary
Q&A-16 of the Notice prescribes (in accordance with Code § 402(c)(9)(B)) the rules by which a trust for the benefit of one or more designated beneficiaries is to be treated in the same manner as a “trust designated beneficiary” for the purposes of the direct rollover to an inherited IRA. Provided that the beneficiaries of the trust meet the requirements to be designated beneficiaries under Code § 401(a)(9)(E) by virtue of the trust meeting the requirements set forth in Treas. Reg. § 1.401(a)(9)-4, Q&A-5 (that is, the trust is valid under state law, is or will be irrevocable on the employee’s death, and has identifiable beneficiaries, and a copy of the agreement or other documentation has been furnished to the plan administrator), a trust beneficiary may establish an inherited IRA to receive a direct rollover. As with an inherited IRA for an individual established under Q&A-13 of the Notice, the IRA must be identified as an IRA of a deceased individual and identify both the deceased individual and the beneficiary (in this case, the trust).
Direct IRA Charitable Distribution for 2006 and 2007
Notice 2007-7 also discusses Code § 408(d)(8), which permits qualified charitable distributions of up to $100,000 per year (for 2006 and 2007 only) to be made directly by the trustee of a traditional IRA or a Roth IRA to certain charities after the IRA owner attains age 70 1/ 2. Qualified charitable distributions are excluded from the account owner’s gross income. The Notice clarifies (and potentially expands) the possible opportunities for qualified distributions in three ways. First, for IRAs from which qualified charitable distributions can be made, the Notice clarifies that, even though the exclusion of the transfer from the IRA account owner’s gross income is not generally available for distributions made from Code § 408(b) simplified employee pension plans or Code § 408(p) simple IRAs, the Code § 408(d)(8)(B) references to these plans apply only to “ongoing” plans (those under which an employer contribution is made for the plan year ending with or within the IRA account owner’s taxable year in which a qualified charitable distribution is made). Q&A-36. Second, the Notice provides that the trustees of an IRA maintained for the benefit of a beneficiary who has attained age 70 1/ 2 before the distribution is made may make qualified charitable distribution. Q&A-37. Third, although the maximum a qualified charitable contribution that may be made from the IRA of a married individual who files a joint return is $100,000 per year, a total of $200,000 may be excluded from income by a married couple if two $100,000 qualified charitable contributions are made, each from an IRA separately owned by each spouse. Q&A-34.
In addition, Q&A-41 confirms that a check from an IRA made payable to a qualified charitable organization that is given to the IRA account owner and then delivered by the IRA account owner to the charity will be considered a direct payment by the IRA trustee to the charitable organization for purposes of Code § 408(d)(8)(B)(i). This forwarding procedure may help to assure that the charitable organization properly reflects and substantiates the source of the contribution. Finally, Q&A-44 states that, from the Department of Labor’s perspective, a qualified charitable distribution will be treated as a receipt by the IRA account owner for purposes of Code § 4975(d)(9) and that the qualified charitable distribution will not constitute a prohibited transaction even if the individual for whose benefit the IRA is maintained had an outstanding pledge to the recipient charitable organization.