NonSpouse Pension Beneficiary

[Jesse]

Effective January 1, 2007 a non-spouse beneficiary is now eligible to roll over a lump sum death benefit into an IRA, correct?

The IRA is then subject to the rules applicable to the beneficiary, correct?

So my client is 49 and has inherited a pension to be paid in a lump sum of $8,495. I am suggesting that they have this directly rolled into an IRA which they can then start taking out w/out penalty after they turn 59 1/2. Financial advisor is saying no they must take equal distributions over a 5 year period. Am I incorrect?

[Bees Knees]

Tell the financial adviser to read up on the new rules.

TTB, page 13-26 says:

Inherited Retirement Plans
New Law: Effective for distributions after December 31, 2006,
benefits from a deceased employee’s eligible retirement plan
may be rolled over directly to an IRA of a beneficiary who is not
the surviving spouse of the employee [IRC §402(c)(11)]. The IRA
is treated as an inherited IRA of the beneficiary. Thus, for example,
distributions from the inherited IRA are subject to the distribution
rules applicable to beneficiaries. The provision applies
to amounts payable to a beneficiary under a qualified retirement
plan, governmental Section 457 plan, or a tax-sheltered annuity.
To the extent provided by regulations, this new rule applies to
benefits payable to a trust maintained for a designated beneficiary
to the same extent it applies to the beneficiary.
Note: The new law does not change the rule that allows a surviving
spouse to treat an inherited IRA as his or her own IRA, or to
roll funds from a deceased spouse’s employer sponsored pension
plan or IRA over to his or her own IRA or employer sponsored
pension plan. [IRC §402(c)(9)]
Author’s Comment: This new law is generally the same as the law that
already existed for non-spouse beneficiaries of IRAs. The new law simply
adds what was already available for inherited IRAs to now apply to
inherited qualified retirement plans.

Information from TTB agrees with the following from page 26 of IRS Publication 590:

Rollover by nonspouse beneficiary. Beginning in 2007,
a direct transfer from a deceased employee’s IRA, qualified
pension, profit-sharing or stock bonus plan, annuity
plan, tax-sheltered annuity (section 403(b)) plan, or governmental
deferred compensation (section 457) plan to an
IRA set up to receive the distribution on your behalf can be
treated as an eligible rollover distribution if you are the
designated beneficiary of the plan and not the employee’s spouse.
The IRA is treated as an inherited IRA.

[Bees Knees]

It should be noted that this rollover IRA cannot be treated as the beneficiary’s own IRA. It is still the decedent's IRA, and the beneficiary has to take the taxable distributions under the rules for distributions that apply to beneficiaries.

TTB, page 13-25 gives the following choices for beneficiaries of IRAs:

Inherited IRA choices. A designated beneficiary has several
choices when inheriting an IRA:
1) The beneficiary can cash in the IRA and pay tax on the distribution,
but no 10% early withdrawal penalty applies since it is
distributed due to the participant’s death.
2) If the beneficiary is an individual, the beneficiary can elect to
take the entire account balance in the IRA by the end of the
fifth year following the year of the participant’s death. No distributions
need to be made before the end of the fifth year.
This election is only available when the participant dies before
the date RMD begins.
3) If the beneficiary is the surviving spouse of the deceased IRA
participant, the beneficiary can treat the IRA as his or her own
IRA. This allows the beneficiary to make additional contributions
to the IRA (including rollover contributions). It also allows
the beneficiary to use the RMD rules based on the beneficiary’s
life.
4) If the beneficiary is the surviving spouse of the deceased IRA
participant, the beneficiary can roll the IRA over to his or her
own IRA, or the taxable portion of the IRA can be rolled over
to his or her employer sponsored pension plan.
5) Beneficiary can leave the IRA in the name of the deceased
participant’s IRA and continue to treat himself or herself as a
beneficiary of the IRA. RMD is determined under one of the
following:
• If the decedent was already receiving RMD at the time of
death, the beneficiary can take out the distributions over the
longer of:
– The beneficiary’s own life based on the Single Lifetime Table
using the age of the beneficiary as of his or her birthday in
the year of the decedent’s death, reduced by one for each
subsequent year, or
– The decedent’s life based on the Single Lifetime Table using
the age of the decedent as of his or her birthday in the year
of death, reduced by one for each subsequent year since.
• If the decedent was not yet receiving RMD at the time of
death, the beneficiary must take out the distributions over
his or her own life based on the Single Lifetime Table. If the
beneficiary was the surviving spouse, RMD does not begin
until the decedent would have turned age 70½.
Choices 1, 2, and 5 above apply to all beneficiaries. Choices 3 and 4
only apply to beneficiaries who are the spouse of the participant.
If the beneficiary chooses number 2 or 5 above, the beneficiary
leaves the IRA in the name of the decedent, or does a trustee to
trustee transfer into an IRA set up and maintained in the name of
the deceased IRA participant for the benefit of the beneficiary.

[newbie]

If the beneficiary opts to take out the distributions over the
longer of the beneficiary’s own life based on the Single Lifetime Table
using the age of the beneficiary as of his or her birthday in
the year of the decedent’s death, reduced by one for each
subsequent year must the beneficiary adhere to this amount each year?

To rephrase, must they adhere to this strict schedule of distributions or if they decide in a future year to take more $$ out will they be penalized?

Does it make a difference if they take more out before they turn 59 1/2?

[Bees Knees]

If the beneficiary opts to take out the distributions over the
longer of the beneficiary’s own life based on the Single Lifetime Table
using the age of the beneficiary as of his or her birthday in
the year of the decedent’s death, reduced by one for each
subsequent year must the beneficiary adhere to this amount each year?

To rephrase, must they adhere to this strict schedule of distributions or if they decide in a future year to take more $$ out will they be penalized?

The rules that require you to take out so much over a period of time fall under the Required Minimum Distribution rules (RMD).

TTB, page 13-25 says:

Distributions greater than RMD. There is no penalty for taking
distributions in excess of RMD, provided the participant is not
subject to any of the early withdrawal penalties (see 10% Penalty
on Early Distributions on page 13-3). However, an excess distribution
in one year cannot be carried over and treated as meeting
RMD requirements for the following year.

Does it make a difference if they take more out before they turn 59 1/2?

TTB, page 13-3 lists the following exception to the 10% penalty:

Distribution to a beneficiary (or the estate) on or after
the death of the participant. Does not apply to modified
endowment contracts.

In other words, anytime the distribution is comming out of an account that is in the name of the decedent and is paid to a beneficiary of that account, the distribution is not subject to the 10% penalty, even though the beneficiary may be under age 59 1/2.

An exception would be a spouse of the decedent who has the option of rolling an inherited IRA into his or her own IRA. At that point, once the funds are co-mingled with your own IRA, it is no longer an inherited IRA, but rather your own IRA, and the exception for a distribution due to death would no longer apply.