On August 17, 2006, President Bush signed into law the Pension Protection Act of 2006. One of its numerous provisions changed the inheritance landscape for unmarried couples, married same-sex couples, and anyone else who may be named as the beneficiary of a non-spouse's retirement plan.
Before PPA went into effect, when a non-spouse inherited assets from a decedent's qualified retirement plan, such as a 401(k) or 403(b), he or she was forced to withdraw most, if not all, assets immediately, triggering a large tax liability. The rationale was that the employer didn't want to bear the administrative cost of having this non-employee on its plan.
The good news is that PPA changed this by allowing all non-spouse beneficiaries who inherit qualified plan assets to roll over their interest into a beneficiary IRA. This allows for the continued tax deferral of accumulation while mandatory distributions are taken over the beneficiary's life expectancy.
The bad news is that the IRS just released notice 2007-7, which basically states employer plans may offer this non-spousal beneficiary rollover option, but aren't required to do so. In other words, a plan can choose to incur the cost of amending its documents to benefit non-spouses, but doesn't have to under the law.
The only loophole is that if a retirement plan currently allows non-spouse beneficiaries to withdraw inherited plan assets over a five-year period, which is more likely the exception than the rule, then the non-spousal rollover is permitted as long as the rollover into the IRA happens before the end of the year following the year of the plan participant's death.
So where do we go from here when it comes to dealing with inactive plans from previous jobs? Back to square one.
In my book, Money Without Matrimony: The Unmarried Couple's Guide to Financial Security, which was published before PPA was enacted, I suggested that individuals with inactive retirement plans from former employers consider the advantages of rolling the assets over to an IRA to maximize their non-spouse beneficiary's tax deferral rather than maintaining the qualified plan account for its enhanced creditor protection. (Assets in a qualified retirement plan are generally untouchable to creditors, while IRA assets could be up for grabs.) Then, in mid-August 2006, I started advising clients to keep the assets in the qualified plan to maintain the creditor protection and enjoy the added benefit of the non-spousal rollover.
Now that the 2007-7 clarification has been issued, I'm going back to my pre-PPA ways. Given the intricacies of this new ruling and the opportunity for error, I am recommending that clients, barring any explicit creditor issues, simply roll old qualified plan assets into IRAs.
Debra Neiman, CFP, is and principal of Neiman & Associates Financial Services, a financial planning firm and registered investment advisor in Watertown, Massachusetts. She's also the co-author of the recently released book, Money Without Matrimony: The Unmarried Couple's Guide to Financial Security.