The Pension Protection Act of 2006, for the first time, permitted non-spouse beneficiaries to have inherited benefits transferred from a qualified retirement plan to an "inherited IRA."
This new non-spouse beneficiary rollover is a tremendously favorable option for many beneficiaries (most often the decedent's children or a "see-through trust") who inherit benefits under a plan that does not offer the life expectancy payout option to beneficiaries. Most 401(k) plans, for example, offer a lump-sum distribution as the only form of death benefit. Now, the beneficiary who inherits such a plan can salvage the life expectancy payout by directing the plan to transfer the lump sum, by a plan-to-plan transfer (direct rollover), into a newly created "inherited IRA," then take the life expectancy payout from the IRA.
But are plans required to offer the beneficiary rollover?
Some practitioners (including me) read the Internal Revenue Code to say, "Yes, plans must offer the beneficiary rollover option."
The Internal Revenue Service surprised us with Notice 2007-7, decreeing that offering such rollovers was optional with the plan. If the plan didn't want to bother with beneficiary rollovers, the beneficiary would still be stuck with the immediately taxable lump-sum distribution, as if the Pension Protection Act had never become law.
This interpretation was most discouraging. If plans are not required to offer the beneficiary rollover, some won't. I already have heard horror stories: A brother and sister who inherited their father's 401(k) plan were told the plan would allow rollovers for a single beneficiary but not for multiple beneficiaries. Another beneficiary's advisor was told that the employer was busy with union negotiations and did not have time to consider a plan amendment to allow beneficiary rollovers.
In August 2007, the "Pension Protection Technical Corrections Act of 2007" was introduced in Congress. According to the Kleinrocks/CCH tax service, this act would provide, among other things, that "[a]ll plans must permit rollovers out of the plan for non-spousal beneficiaries." Though this bill has not yet been enacted, the gist was clear.
The IRS promptly responded by including the following paragraph in its document entitled "2007 Cumulative and Interim Amendments," which is posted online at www.irs.gov/retirement/article/0,,id=173372,00.html: "§ 402(c)(11) [Discretionary]: PPA '06 § 829(a)(1) added § 402(c)(11) to allow nonspouse beneficiaries to roll over distributions from a qualified plan to an individual retirement plan. Nonspouse beneficiary rollovers are an optional plan provision for 2007. See, Notice 2007-7. Pursuant to an impending technical correction, nonspouse 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 paragraph led some practitioners (including me) to conclude that the IRS now was admitting (as a result of reading the Technical Corrections Act) that Congress intended all along for beneficiary rollovers to be mandatory for the plan, and accordingly the IRS would so require beginning with the 2008 plan year.
That may have been wishful thinking. A more skeptical reading of the IRS' midsummer online posting would suggest that, yeah, technical corrections MAY make beneficiary rollovers mandatory on plans beginning in 2008, but until that technical corrections bill passes, we here at the IRS are going to stick to our original interpretation: Plans don't have to offer these rollovers!
IRS Notice 2007-94, the "2007 Cumulative List of Changes in Plan qualification Requirements" supports this unfortunate conclusion. The IRS publishes this list annually to help employers keep up with the never-ending changes they must make to keep their retirement plans qualified. Section VI of the notice deals with amendments that will be required to comply with the Pension Protection Act. Paragraph 10 of Section VI deals with Section 402(c)(11). It refers the reader back to Notice 2007-7, which of course, says that beneficiary rollovers are strictly optional, at the discretion of the plan. There is no mention of any pending technical corrections, and no mention of such rollovers becoming mandatory in 2008.
So, as 2007 comes to a close, we are back where we were at the beginning of the year when Notice 2007-7 came out. Unless and until Congress actually passes technical corrections to the Pension Protection Act to make it clear enough for even the IRS to understand that plans MUST offer beneficiaries this option, plans will apparently continue to be able to refuse to allow it -- with the IRS' blessing. Stay tuned.