Beneficiary Rollover of Roth 401(k) Nonqualified Distribution

[ERISAAPPLE]

The way I read the regs and all the guidance, including the IRS publications, and even Natalie Choate's book (which is wonderful, but I could not find where it addresses these questions), if a beneficiary rolls over the Roth 401(k) of a deceased participant to an inherited Roth IRA, and at death the participant did not meet the five-year rule, the following are the tax results. 

1.  The rollover is not taxable.  

2.  A new five-year holding period starts for the beneficiary's inherited IRA. 

3.  We don't worry about 59 1/2 because the distribution was on account of death.  

4.  The only way the beneficiary can avoid taxation on the earnings is to meet the 5-year holding rule.  If the 5-year RMD rule applies to the inherited Roth IRA, then all earnings will be taxed, including pre-rollover and post-rollover.  

I read a website that suggested a non-spouse beneficiary cannot roll over a 401(k) Roth that is not a qualified distribution, but I don't think that is correct.

Finally, if the beneficiary rolls over a Roth 401(k) that is qualified (because the participant had the Roth 401(k) for five years), the post-rollover earnings are still subject to a new 5-year holding period.  

This is all very confusing and the guidance is not clear.   Does anyone have thoughts on this?  

[Larry Starr]

I can't get to this item currently to analyze (yes, heading off to ANOTHER boat trip next week), but I have spoken with Natalie a number of times and she welcome questions sent to her that are not adequately dealt with in the book.  She often puts out the answers in her blog and eventually incorporates the material into future versions of the book.  You should send her the issue; she might even reply to you (she has to me). 

[card]

I'm surprised there's nothing explicit from the Service on this--I thought there was. But then again, I'm constantly surprised...

Your summary seems  logical as this would generally be the tax result if the participant had rolled the funds over from the Roth 401(k) to a Roth IRA (except of course for the penalty exception, and the ability to use an older Roth IRA to calculate the holding period).

Your observation in paragraph 4 that the beneficiary is screwed if the 5-year RMD rule applies unfortunately seems correct...

 

[ERISAAPPLE]

4 hours ago, card said:

I'm surprised there's nothing explicit from the Service on this--I thought there was. But then again, I'm constantly surprised...

Your summary seems  logical as this would generally be the tax result if the participant had rolled the funds over from the Roth 401(k) to a Roth IRA (except of course for the penalty exception, and the ability to use an older Roth IRA to calculate the holding period).

Your observation in paragraph 4 that the beneficiary is screwed if the 5-year RMD rule applies unfortunately seems correct...

 

Card, those were my thoughts too.  Why should a beneficiary be given better tax treatment than the participant would receive had he lived?  The best move for a nonspouse beneficiary is either (1) make sure  he is using the life expectancy rule or (2) if he is going to use the 5-year rule get the money into the inherited Roth IRA in the year of death, which gives him the chance to meet the Roth 5-year holding rule before the 5-year RMD period ends (the RMD 5-year rule is actually 5 years after the year of death, and the 5-year Roth holding rule would begin January 1 in the year of death assuming the inherited Roth IRA is opened that same year).  The nonspouse beneficiary could always take out the investment in the contract tax-free, and the 72(t) 10% penalty will not apply.