Anyone dealing with a retirement account probably has heard the term "rollover," (or as a verb, "roll over"). An individual who has left employment and moved a 401k account balance to a new retirement plan or an individual retirement account (IRA) has engaged in the rollover of an account. There are several kinds of transfers of retirement accounts and IRAs that commonly are referred to as rollovers. This summary describes the various types of transfers that fall under the term "rollover."
Rollover by Account Owner
A distribution of all or a portion of the balance to the credit of an employee in a retirement plan can be rolled over to another qualified plan or an IRA. The rollover must be made within 60 days. The IRS can waive the 60-day requirement for good cause. A rollover is not available for amounts required to be distributed under the minimum distribution rules or payments being received under a form of elected annuity distribution.
Strictly speaking, a rollover indicates an actual distribution of the account proceeds, which the recipient then deposits into a new account within 60 days. In practice, the better way to transfer retirement account funds is to request a direct account-to-account transfer by the plan or account custodian. Most professionals and taxpayers also refer to this process as a rollover. The advantage of a direct transfer is that it avoids the mandatory withholding rules that apply to rollovers. An individual who actually takes receipt of a plan or IRA balance will have 20% withheld for taxes, and will have to use other funds to complete a rollover of the full amount and request a refund of the taxes withheld.
Under Section 402(c)(9) of the Internal Revenue Code, for any distribution attributable to an employee that is paid to the spouse of the employee after the employee's death, the rollover rules will be available to the spouse to the same extent they were available to the employee.This rule also applies to IRAs.
The rollover option allows a surviving spouse to move account proceeds tax-free to his or her own IRA, and take maximum advantage of the income tax deferral rules, including the ability to forgo distributions until age 70½, and to designate a beneficiary who can take distributions over his or her life expectancy after the death of the spouse.
A rollover is available to a spouse who acquired the account "by reason of the owner's death." In general, if a decedent's retirement account or IRA passes to his or her estate or a trust and then to the surviving spouse, the entity is considered to acquire the account, and the spouse cannot roll over the account to his or her own IRA. A spousal rollover often can be salvaged even when the decedent did not properly designate the spouse as beneficiary. The IRS still will allow a rollover if the spouse can dictate all the actions necessary to cause the account to be paid to him or her. For example, in Letter Ruling 201523019 (June 5, 2015), the decedent's beneficiary designation was 50% to the surviving spouse and 50% to the couple's joint trust, of which the surviving spouse was trustee. The spouse proposed to allocate the trust's 50% to a Marital Trust under the terms of the joint trust, and then exercise her right of withdrawal to take the proceeds and roll them over to her own IRA. Because the spouse, as trustee and beneficiary, had complete control as to the disposition of the account proceeds, the IRS ruled she would be treated as receiving the proceeds directly from the decedent's account and eligible to roll over the amounts to her own IRA.
The Service reached the same conclusion in Letter Ruling 201507040 (Feb. 13, 2015) on almost identical facts. It also allowed a spousal rollover in Letter Ruling 200603036, even though the spouse had to exercise her authority as trustee to make a discretionary distribution to herself to acquire the retirement account proceeds. While these private letter rulings protect only the taxpayer who requested them, they are indicative of a consistent IRS policy to liberally allow spousal rollovers.
Inherited Account Rollover
When an IRA account holder dies with an individual named as beneficiary, the account balance can be transferred to a new account for the designated beneficiary. This is generally referred to as an inherited IRA.
The Pension Protection Act of 2006 extended the inherited IRA option to beneficiaries of 401ks and other employer plans. 401ks and other employer plans could always allow a non-spouse beneficiary to take distributions over his or her life expectancy. However, many plans did not offer this option, and forced a non-spouse beneficiary to take a lump-sum distribution, usually no later than 5 years after the date of death, and incur the income taxes on all of the benefits at that time. The Pension Protection Act added Section 402(c)(11) to allow a non-spouse beneficiary the option of rolling over 401k or other plan benefits to an inherited IRA.
In general, only a plan participant and the participant's spouse can take advantage of a true rollover – the transfer of the plan assets to his or her own IRA, in his or her own name. The rollover to an inherited IRA is different than a true rollover. With an inherited IRA, the beneficiary can take distributions over his or her own life expectancy (or if the participant was past age 70½ at death and had a longer life expectancy than the beneficiary, over the participant's life expectancy). However, the IRA is not the beneficiary's own account. He or she cannot defer taking distributions until age 70½, and cannot allow a further designated beneficiary of the IRA to take distributions following the recipient's death over that beneficiary's life expectancy.
EXAMPLE: Mom, age 65, dies with a 401k plan of which she was the owner and her daughter, Rachel, age 35, is the designated beneficiary. Rachel can choose to roll Mom's 401k plan to an inherited IRA and take distributions from the inherited IRA over her lifetime. Rachel must take her first distribution by the end of the year following the year of Mom's death.
EXAMPLE: Dad, age 75, dies with a 401k plan of which he was the owner and his son, Fred, age 40, is the beneficiary. Fred, can choose to roll Dad's 401k plan to an inherited IRA and take the distributions from it over his life. Fred must take his first distribution by the end of the year following the year of Dad's death. If Dad did not receive his minimum distribution in year he died, Fred also will need to take that minimum distribution before the funds are moved into the inherited IRA
EXAMPLE: John, age 72, dies with a 401k plan of which he was the owner and his sister, Joanne, age 80, is the beneficiary. Joanne can choose to roll John's 401k plan to an inherited IRA and, because John's life expectancy was longer than Joanne's life expectancy, to take the distributions over John's life expectancy.
Only a trustee-to-trustee transfer to the inherited rollover account will qualify under Section 402(c)(11).
The IRS provided guidance on the rollover provision in Notice 2007-7, 2007-5 I.R.B. 395. The Notice stated that the direct rollover provision is available to the non-spouse beneficiary of any qualified plan described in Section 401(a) of the Code. It also is available for annuity plans described in Section 403(a) or (b) and eligible governmental plans under Section 457(b).
A trust that is the named beneficiary of a plan, and which meets the requirements to be a designated beneficiary, is eligible for the direct rollover option. The trust would establish the IRA in the name of the trust, for example, "John Smith Family Trust, as beneficiary of John Smith."
For reasons not fully understood, the IRS provided strict rules in Notice 2007-7 for the rollover in order to qualify for life expectancy distributions in the inherited IRA, in particular where the employee died before his or her required beginning date (RBD). In the case of death before the RBD, and if the 5-year rule would have applied under the plan, then to qualify for life expectancy minimum distributions in the inherited IRA, the plan benefits must be rolled over to the inherited IRA by the end of the year following the year of death. If this does not occur, then the beneficiary still can roll over the plan benefits, but he or she remains subject to the 5-year payout rule.
For a decedent who died before the RBD, the beneficiary can (i) roll over the entire account in the year of death; or (ii) in the year following the year of death, take a required minimum distribution based on the beneficiary's life expectancy and roll over the balance to an inherited IRA before the end of the year.
For a decedent who died after the RBD, the beneficiary should first, in the year of death, complete the required minimum distribution for the decedent if it was not taken. The balance of the account can be rolled over to the inherited IRA. If the account is not rolled over in the year of death, then the beneficiary can complete the roll over in any subsequent year, as long as the beneficiary has first taken his or her required minimum distribution for that year and prior years.