In the January issue (which went to press in early December), I said that the Internal Revenue Service had reversed its position, and was now requiring company retirement plans to allow non-spouse rollovers in 2008. Not so fast! On Dec. 29, 2007, President Bush signed The Tax Technical Corrections Act of 2007 into law (H.R. 4839) as expected. But mysteriously, it doesn't include the provision making the non-spouse rollover mandatory for 2008. Then in January 2008, the IRS released Publication 590 on IRAs, noting that the provision is effective, but there is no mention of whether it's mandatory or optional. It's enough to give a planner a headache.

So what's the rule on non-spouse rollovers from company plans under the Pension Protection Act (PPA) of 2006? Do company plans have to allow this or not? Who knows? It now appears that the non-spouse rollover provision will not be mandatory for 2008 until either the IRS or Congress issues official guidance otherwise. As a result, we must assume that the provision remains optional.

The Whole Story

The PPA included a provision that would permit non-spouse plan beneficiaries to make direct transfers from a company plan to a properly titled inherited IRA. The beneficiaries could then take stretch distributions over their lifetime instead of being subject to the harsh payout rules of most company plans. This provision became effective in 2007. But the provision lost its steam when the IRS released Notice 2007-7 in January 2007, which stated that the provision was not mandatory for plans.

This created confusion and was contrary to what Congress intended. Congress realized this and proposed a technical correction to the law that stated that employer plans must allow the non-spouse direct rollover to an inherited IRA. In light of the pending congressional technical correction, the IRS reversed its position and said that the non-spouse rollover provision would be mandatory beginning in 2008. There was no official announcement on this, other than a posting on the IRS website. In fact, as of January 2008, the posting is still there.

This provision, however, was not in the bill that was passed and signed by President Bush at the end of 2007, and it may not end up in the bill currently pending in Congress. A later posting on the IRS website is silent on the issue. It appears that the provision has gone away, like a bad dream. Barring any future changes, Notice 2007-7 is still the authority, meaning that the provision remains voluntary.

This is bad news for non-spouse beneficiaries such as children, grandchildren, friends and unmarried couples (even if they are legally married under state law). If a company plan doesn't allow a non-spouse direct rollover, these beneficiaries will most likely be forced to withdraw the inherited plan balances in five years or less after the owner's death. They won't be able to extend the tax deferral over their lifetime through a stretch IRA.

How To Do the Transfer

If a company does allow non-spousal transfers, the transfers must be direct (trustee to trustee), and they must be done by the end of the year following the year of death. In addition, beneficiaries must take the first required minimum distribution from the inherited IRA by that same deadline (the end of the year following the year of death). If a transfer doesn't meet these deadlines, the beneficiary will still be able to do the transfer, but will be stuck with the usually less favorable payout option of the plan (probably the five-year rule) instead of getting to stretch the payments over his or her lifetime.

When funds are turned over to a beneficiary (not as a direct transfer), the beneficiary cannot correct the error and transfer those funds to a properly titled inherited IRA. Instead, the entire amount of the distribution will be taxable, and that will be the end of the tax shelter.

The direct transfer must be to a properly titled inherited IRA. The name of the deceased plan participant must be in the title of the inherited IRA. One example of proper account titling for an inherited IRA would be Bob Jones, deceased (Nov. 28, 2007), IRA f/b/o Jane Jones where Bob Jones was the father and 401(k) participant, and Jane Jones his daughter, the beneficiary of his 401(k) plan.

A trust is a non-spouse beneficiary too. In order to take advantage of the non-spouse transfer provision, the trust must qualify as a "see-through" or "look-through" trust under IRS requirements. To qualify the trust must be valid under state law and irrevocable after death; the trust beneficiaries must be identifiable and must all be individuals; and the trust documentation or the trust itself must be delivered to the plan administrator by October 31 of the year following the year of death. A trust that does not qualify cannot do a direct transfer to an inherited IRA.