In our first LISI Employee Benefits and Retirement Planning Newsletter of 2008, Natalie B. Choate of Bingham McCutchen, LLP, Boston, author of Life and Death Planning for Retirement Benefits and The QPRT Manual (both books available through http://www.ataxplan.com/ ) ponders,

"Will beneficiary rollovers be mandatory on plans in 2008—or not?"

EXECUTIVE SUMMARY:

Earlier this year, it appeared that non-spouse beneficiary rollovers would be made mandatory on plans beginning in 2008.

That was then, this is now.

Both Congress and the IRS seem to have backed off, leaving us with the "Notice 2007-7" status quo still in place:

Plans do not have to offer beneficiary rollovers after all!

FACTS:

BACKGROUND:

As reported in LISI's Employee Benefits & Retirement Planning Newsletter # 432 (10/23/07), under the Pension Protection Act of 2006 (PPA 2006), effective for 2007 and later years, the "designated beneficiary" of a decedent's qualified, 403(b), or 457 plan can open an "inherited IRA" (which isn't really inherited) in the name of the deceased plan participant, and payable to the beneficiary. IRC § 402(c)(11).

Then, the plan sends the lump sum distribution to the newly-created "inherited" IRA via plan-to-plan transfer, and presto the beneficiary can have his life expectancy payout (from the "inherited" IRA), even though that was not a permitted form of distribution under the plan he or she actually inherited.

Though some practitioners read § 402(c)(11) as requiring plans to allow such "beneficiary rollovers," the IRS disagreed. IRS Notice 2007-7 provided that plans would not be required to allow beneficiary rollovers. The plan could allow the beneficiary rollover, or not, depending on the plan's whim.

WHAT HAPPENED NEXT:

The IRS's interpretation seemed contrary to Congressional intent. If plans were not required to offer the beneficiary rollover, some (many?) plans would choose not to offer it, and nonspouse beneficiaries would be right back where they were before PPA 2006—stuck with a non-rollable immediately-taxable lump sum distribution.

Then, in August 2007, the "Pension Protection Technical Corrections Act of 2007" (S. 1974), was introduced in Congress, making "technical and clarifying changes" to PPA 2006.

If enacted, this legislation would have made it clear that plans were required to offer the beneficiary rollover, by adding to § 401(a)(31)(D) a statement that the term "eligible rollover distribution" included distributions under § 402(c)(11). (Plans are required to offer "direct rollovers" of eligible rollover distributions; § 401(a)(31)(B).) Inclusion of this provision in a technical corrections bill led to a strong inference that this is what Congress had intended all along.

The IRS swiftly responded: In its list of "2007 Cumulative and Interim Amendments," posted at the IRS website in August 2007, the IRS included the following paragraph:

"§ 402(c)(11) [Discretionary]: PPA '06 § 829(a)(1) added § 402(c)(11) to allow non-spouse beneficiaries to roll over distributions from a qualified plan to an individual retirement plan. Non-spouse beneficiary rollovers are an optional plan provision for 2007. See, Notice 2007-7. Pursuant to an impending technical correction, non-spouse beneficiary rollovers will be required for plan years beginning on or after January 1, 2008. See, section 9(e) of S. 1974, the Pension Protection Technical Corrections Act of 2007, as introduced in the Senate on August 2, 2007 and section 9(e) of H.R. 3361, the Pension Protection Technical Corrections Act of 2007, as introduced in the House of Representatives on August 3, 2007." Emphasis added.

This seemed to say that the IRS, now that it understood Congress's intent as clarified by the proposed legislation, would start requiring plans to offer beneficiary rollovers in 2008.

However, it now appears that the IRS was merely reciting what the technical corrections bill said…and not in any way implying that the IRS would go along with this expression of Congressional intent if not forced to do so.

Summer has turned into winter. The leaves have disappeared, and the August version of technical corrections went with them.

THE LATEST – BUT NOT - GREATEST:

A new version of technical corrections is now proposed in Congress, the "Tax Technical Corrections Bill of 2007" (S. 2374, H.R. 4195). The new version says nothing about beneficiary rollovers; the provision clarifying that beneficiary rollovers are mandatory on plans is gone without a trace. And the IRS has issued its annual list of amendments that qualified retirement plans must adopt in order to stay qualified, Notice 2007-94.

For guidance on implementing beneficiary rollovers, this "2007 Cumulative List of Changes in Plan Qualification Requirements" refers only to Notice 2007-7…which of course says that beneficiary rollovers are optional for the plan. There is no mention of mandatory beneficiary rollovers coming in 2008 or any other time.

WHY PLANS DON'T OFFER BENEFICIARIES ROLLOVERS?

Why don't plans want to offer the beneficiary rollover? For some employers and plan administrators, it's just one more thing to worry about. It's easier for the plan to write a check to the named beneficiary than to get involved with transferring funds to an inherited IRA.

For a while it looked like Congress had really fixed the problem of inherited lump-sum-only  plans, but now this feels like the oldest movie plot in the book: It was all just a dream!

Who needs the beneficiary rollover anyway? Why, only the children of parents who die prematurely (and parents of children who die prematurely).

Most people don't die while they still have money in a 401(k) plan. Most people survive to retire and roll their benefits over to an IRA; and beneficiaries who inherit an IRA can always get a life expectancy payout, because all IRAs offer it.

THE DOUBLE WHAMMY PROBLEM:

But for the survivors of those who are unfortunate enough to die while still working, there will continue to be a double whammy:

First, you lost your parent (child, sibling, friend) at a far-too-young age, and to add insult to injury…

Second, you have no option other than an immediately taxable lump sum distribution of your loved one's pension benefits.

Yes, the Code says you can take a life expectancy payout.

But that's only if the plan chooses to offer that form of benefit—and most do not offer it.

Yes, the Code says the benefits can be transferred to an inherited IRA.

But that's only if the plan chooses to offer such rollovers (apparently)—and many will choose not to offer them.

BOTTOM LINE:

For now, beneficiary rollovers continue to be optional with the plan, and there is nothing on the horizon that will change that.

Should we be surprised that the plan administrator lobby is stronger than the lobby for beneficiaries of those who die prematurely?

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Natalie Choate

CITE AS:

LISI Employee Benefits and Retirement Planning Newsletter # 438  (January 1, 2008) at http://www.leimbergservices.com/  Copyright 2007 Leimberg Information Services, Inc. (LISI).  Reproduction in ANY Form or Forwarding to ANY Person Prohibited – Without Express Permission.

CITES:

§ 402(c)(11), added to the Code by § 829(a)(1) of PPA 2006; IRS Notice 2007-7, 2007-5 I.R.B. 395 (January 2007); IRS list of "2007 Cumulative and Interim Amendments" posted at http://www.irs.gov/retirement/article/0,,id=173372,00.html  (if you have trouble finding this item on the irs.gov website, try searching the term "2007-7," then sort your results by date); and Notice 2007-94, 2007-51 I.R.B. 1179.

The author thanks LISI Member Michelle O'Haren  for catching this latest IRS flip-flop.