A bill pending in Congress could create a significant estate-planning opportunity for family members other than spouses.
Currently, someone other than a spouse who is the beneficiary of a retirement plan must distribute inherited assets on a payout schedule that is set by the plan administrator. Typically the time period is five years or less, and taxes must be paid within that timeframe.
But if the bill becomes law, family members beyond spouses could take advantage of more favorable payout schedules by transferring the money into an inherited IRA. Then they can stretch account distributions over the course of their lifetimes, and get the benefit of a lifetime of tax-deferred growth, according to Ed Slott, a Melville, New York-based CPA and IRA expert.
Spouses are already allowed to make such transfers under current law.
The Pension Protection Technical Corrections Act of 2007 contains a provision that would mandate that administrators of employer-sponsored retirement plans, such as 403(b) and 457 plans, allow non-spouse beneficiaries of these accounts to roll over assets into inherited individual retirement accounts following the plan participant's death.
A "stretch" option allows beneficiaries to take annual distributions while the balance compounds tax-deferred -- a huge benefit that many non-spouse beneficiaries, such as grandchildren, forego if retirement plan administrators require them to adhere to their own payout schedules, which is often only five years, according to Slott.
"You could lose the potential build-up
under present law because the money diminishes more quickly, and so does the overall value to the family," Slott says. "But if you can stretch $50,000, tax-deferred, over 40 years, you'll have millions."
Slott says the legislation is likely to pass.
"This change will affect every public and privately sponsored pension and qualified retirement plan in the nation if it happens -- and we'll see billions of dollars of rollovers into IRA accounts," according to Sy Goldberg, a Jericho, N.Y.-based attorney and expert in retirement-plan distributions.
Goldberg says he is aware of many plans that require non-spouse beneficiaries to take a lump-sum distribution from the plan, making it completely taxable in just one year and squandering potential decades of tax-deferred compounded growth.
Plan administrators must already offer spousal beneficiaries of retirement accounts -- husbands and wives -- the option to rollover retirement plan funds into inherited IRAs. The correction, which would become effective in 2008, would ensure the benefit also applies to non-spousal beneficiaries, such as children, grandchildren and domestic partners.
"A lot of plan administrators thought twice about offering the option
of non-spousal beneficiary rollovers because it added complications," explains Michael Olah, director of corporate and retirement services for
in San Francisco. "But the change would be an added benefit to beneficiaries -- it would give them a lot of flexibility in terms of planning."
Technical corrections acts generally attempt to rectify inadvertent errors and oversights enacted as part of legislation. This particular correction applies to the Pension Protection Act of 2006, the most sweeping pension reform legislation passed in the U.S. in 30 years, which contained the provision allowing such rollovers by non-spousal beneficiaries.
The IRS, however, announced in January that retirement plan administrators were not bound by the provision -- they could allow rollovers by non-spousal beneficiaries or not. Congress responded by clarifying the issue in the technical corrections bill that's now pending.
"There's a high chance the change will become mandatory," says Susan Hartman, a tax and estate planning consultant for
Raymond James Financial
in St. Petersburg, Fla. "Then retirement plan administrators won't be able to point to the notice saying it's optional," she says. "They'll be required to provide the alternative."
Non-spouse beneficiaries who elect to roll over retirement-account distributions into inherited IRAs must be certain to make a direct transfer into an account that's properly titled, cautions Slott. That means the name of the deceased plan participant must appear in the title of the IRA, such as Mary Brown IRA (deceased June 1, 2007).
"The change would create an opportunity for estate planning throughout the U.S. that didn't exist before," Goldberg says.
Suzanne Barlyn is a writer in Washington Crossing, Pa.