Prior Law

Prior to 2007, spouses were the only beneficiaries who could make a nontaxable rollover of a deceased’s interest in an employer retirement plan to an IRA. Nonspouse beneficiaries had to take taxable distributions from the plan according to the plan’s terms, which typically required the entire balance to be paid out by the end of the fifth year following the decedent’s death. No payouts were typically required in years one through four, but the entire balance had to be distributed by the end of year five. Income taxes had to be paid on the distributions, and there was no way for nonspouse beneficiaries to extend payouts beyond the plan’s terms. Some plans allowed a life expectancy payout for nonspouse beneficiaries, but this option was not very common.

New Law

Starting in 2007, nonspouse beneficiaries can make a direct rollover (a trustee-to-trustee transfer) of inherited employer plan funds to an inherited IRA. The IRS recently provided guidance on how to apply this provision. Funds can be rolled over from 401(k), 403(b), and section 457 plans. When funds are rolled over, they must go to a properly titled inherited IRA that retains the decedent’s name in the title. However, a plan does not have to give nonspouse beneficiaries the ability to roll funds over to an inherited IRA. It is up to the plan.

Funds must be made via a trustee-to-trustee transfer. If the funds are issued to the beneficiary via check, it is considered a distribution and those funds cannot be rolled over to an IRA. If a plan won’t make a trustee-to-trustee transfer, a check can be made out to the inherited IRA and still meet the requirements.

Once funds are rolled over, the distribution rules that applied when the funds were in the employer’s plan continue to apply, unless a special rule is followed. To escape the plan’s rules, the beneficiary must take the first required distribution using the beneficiary’s life expectancy by the end of the year following the decedent’s death. If this is not done, the beneficiary must take distributions based on the plan’s rules, which generally require the entire balance to be withdrawn in five years.