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  • Home>Practice Management>Retiring With Natalie Choate>Navigating a Nonspouse Beneficiary Rollover From a Pension Plan

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    Navigating a Nonspouse Beneficiary Rollover From a Pension Plan

    Designated beneficiaries are entitled to some--not all--of the same rollover rights as a retiring employee or surviving spouse.

    Natalie Choate, 04/12/2017

    Question: "Nick" worked at Acme Co. He died in 2016, leaving his Acme Pension Plan death benefit (a lump sum) to the "Nick Revocable Trust." The trust provides that all trust assets are to be held and administered for the benefit of Nick's son, Junior, until Junior reaches age 30, at which time the trust is to terminate and all its assets are to be transferred outright to Junior. However, Junior was already age 38 when Nick died--obviously well past age 30, but Nick had never updated his estate plan. Junior wants to have the plan benefits transferred directly into an inherited IRA for him, or at least into an inherited IRA in the trust's name (so it can then be transferred to an inherited IRA for Junior). How do we convince the plan administrator that this is permitted?

    Answer: What you are seeking is perfectly legal. In fact, the plan is required to comply with the trustee’s request--or risk losing its status as a qualified plan! Here's why.

    A "designated beneficiary" is entitled to some, not all, of the same rollover rights as a retiring employee or a surviving spouse. Specifically, the designated beneficiary of a deceased employee is entitled to have the death benefits payable to him paid, instead, directly into an "inherited IRA" established to receive the distribution. Not only must the plan provide this option to the designated beneficiary, but the plan must give full notice and explanation of the direct rollover option to the beneficiary, just as it must do for a retiring employee or surviving spouse.

    There is some confusion on this point for the following reason. The code was first amended to permit nonspouse beneficiary direct rollovers by the Pension Protection Act of 2006, which added §402(c)(11) to the code. Though this section appeared (to some people) to establish nonspouse beneficiary direct rollovers as a right on the same basis as employee and surviving spouse-rollovers, plan administrators and the IRS interpreted it as merely allowing such rollovers, not requiring the plan to offer them. So the IRS issued rules to the effect that a plan could, but was not required to, offer the nonspouse beneficiary rollover. See IRS Notice 2007-7, A-14 and A-15.

    So, effective for 2010 and later years, Congress amended the code again, to clarify that the term "eligible rollover distribution" (the phrase that triggers the plan’s obligation to provide direct rollovers and offer complete explanations to recipients) includes distributions to designated beneficiaries under §402(c)(11). In other words, a designated beneficiary has the same right as a retiring employee or a surviving spouse-beneficiary: The right to have an eligible rollover distribution transferred directly to an IRA for such beneficiary’s benefit.

    The plan can have reasonable administrative rules regarding these transfers. (For example, the plan is not required to permit transfer into multiple separate IRAs--though it can do so.) However, the plan cannot impose rules that unreasonably burden the rollover right. For example, the plan cannot require the beneficiary to supply a legal opinion regarding the eligibility of the recipient plan or an indemnification agreement from the recipient plan.

    The direct rollover right is not available to every beneficiary. It is available only for a "designated" beneficiary. When the named beneficiary of the retirement plan is a trust, the trust itself cannot be a "designated beneficiary" because a trust is not an individual. The trust must qualify as a "see-through trust" under IRS regulations in order for the individual trust beneficiaries to be considered “designated beneficiaries” for purposes of the minimum distribution rules and, by extension, for purposes of the rule allowing the direct rollover option to (only) designated beneficiaries.

    In your case, since the terms of the trust require immediate outright distribution of all trust assets to one individual, namely Junior, it qualifies as a see-through trust assuming the other requirements are met (copy of the trust sent to plan administrator, etc.).

    Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is a leading resource for professionals in this field.

    The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.