Non-spousal beneficiaries
What is the status of a non-spousal beneficiary inheriting a tax-qualified plan such as a Keogh Plan, 403(b), 401(k), or 457 plan. Will the non-spousal beneficiary have to immediately pay taxes on the full amount of the above mentioned tax-qualified plans? I am aware of what would happen if the money is in an IRA. Did the tax act of 2006 that was passed change anything in regard to the above situation?
Permalink Submitted by Alan Spross on Thu, 2008-06-05 02:32
Yes, the Pension Protection Act provides for non spouse transfers to inherited IRA accounts, and effective this year even to inherited Roth IRA accounts. But one of the problems is that the IRS has ruled that these transfers are optional on the part of the plans. There is a technical corrections act pending in Congress that will make these transfers mandatory, and it is expected to be adopted.
Right now, having a plan that will allow the transfer is only half the battle. The transfer must still be completed by no later than 12/31 of the year following the owner’s death in order for RMDs from the inherited IRA to be taken over the beneficiary’s life expectancy if the owner passed prior to the required beginning date, and the plan had more restrictive conditions. If the transfer is done later, the provisions of the plan must apply to the IRA, and that is usually the 5 year rule and loss of tax deferral. While some plans may require a full distribution in one year, most of them use the 5 year rule.
Permalink Submitted by Kurt Miller on Sat, 2008-06-07 18:56
my friend’s sister named him as beneficiary on her 401k. She sied of cancer last fall. How does he make it a stretch 401k? First, it seems that the plan may not allow it — I had him ask and he has not heard back yet. If the plan allows it, does he then just re-title it correctly and go from there or does he have to set up something for himself? I believe from what I understand, that is not possible but I did not want to leave any ? unsaid. And then there are her 2 kids, 12 and 4. Can he somehow get it to them without paying much tax?
Permalink Submitted by Alan Spross on Sat, 2008-06-07 20:43
With children that young I assume she passed prior to her required beginning date.
Depending on the plan provisions, your friend may be facing a critical date this December, and therefore he needs to get ahold of the plan administrator and get some questions answered:
1) Does the plan provide for the direct transfer of his interest to an inherited IRA account?
2) If not what are the plan provisions that apply to owner’s death if the owner died prior to the required beginning date? What elections must he make and when to avoid the 5 year rule from applying?
With respect to the kids, if they were named as contingent beneficiaries, he can disclaim the account and it will pass to them. If not named, a disclaimer is less clear and the plan provisions would need to be determined as to a default beneficiary. Usually, the default beneficiary would be the spouse, if any, or the estate. With all these complications, he should get some competent legal help since state laws come into play with respect to financial guardianship for the kids, and he would also need legal help if a disclaimer was a viable way to go.
Of course, he could take taxable distributions himself and gift the amount he deems appropriate to the kids or their guardian, but there will be an RMD due this year and every year. The desirability of incurring legal costs to pursue a disclaimer depends on how much is in the account.
Permalink Submitted by Kurt Miller on Mon, 2008-06-09 00:52
Thanks, Alan,
He does not have an inherited IRA set up, yet. Can he set one up now and do the roll-over if allowed by the plan?
Also, the kids were not named as contingent so it probably would be her estate. Financial guardianship would probably revert to their fathers and that was not her wishes.
Best regards,
Kurt Miller
Permalink Submitted by Alan Spross on Mon, 2008-06-09 04:15
Yes, if the plan allows it, the assets can be transferred to an inherited IRA for him. The transfer must be direct and he needs to be sure he does not indicate a distribution. A check made out to him cannot be rolled over.
He would then retain control of the funds and could explore ways to help the kids out. Any assets passing to the kids would be subject to the state laws addressing guardianship issues for minors, whether they received funds via the estate or directly as IRA beneficiaries.
Permalink Submitted by Kurt Miller on Mon, 2008-06-09 11:17
So he can set up an inherited IRA after his sister’s death even if he did not have one when she was dying?