Nonspouse Rollover and WRERA

[RTK]

A question revisited in the context of WRERA.

Plan uses 5 year rule (only) for RMDs to nonspouse beneficiaries.

Q&A 17©(2) of IRS Notice 2007-7 provides that the nonspouse beneficiary may determine the RMD "under" the plan using the LE rule if distribution is made before the end of the year following the year of participant's death. Kinda sounded like the plan had to use the LE rule if the nonspouse beneficiary applied for distribution in year 1 following the death, but not in year 0 or years 2-4. If so, notwithstanding the plan terms providing for the 5 year rule, the plan would have to implement procedures to calculate a RMD in year 1 (only) under the LE rule and offer a direct rollover only for the balance of the distribution in excess of RMD.

IRS 2-13-07 employee plan news special edition explains this stating that the nonspouse beneficiary may "treat" the plan as using the LE rule for determining the amount eligible for rollover and the IRA RMD. Kinda sounded like the plan did not have to apply the LE rule, but nonspouse beneficiary would. The example did not help clarify this by noting "the amount eligible for rollover" must be reduced by the RMD calculated using the LE rule. A tad bit awkward, since a nonspouse beneficiary can only do a direct rollover. Thus, the plan would be offering a direct rollover for an amount the nonspouse beneficiary is not eligible to rollover, and the beneficiary would have to either elect a direct rollover for only the eligible portion of the distribution or take the correct RMD from the IRA after rollover of the entire amount. This requires a pretty savvy beneficiary.

I guess you could boil this down to whether in year 1 the RMD had to be paid by the plan or taken from the IRA (if the nonspouse beneficiary applied for distribution). A number of commentators seemed to lean towards payment of the RMD from the plan. But that was troubling, because the 401(a)(9) regs allow a plan to use only the 5-year rule, and the special LE rule would apply to the plan only if the nonspouse beneficiary actually elected a distribution in year 1 (not the easiest thing to explain to a plan administrator). I can't remember seeing any straight forward guidance on this from the IRS. The one paragraph in the new 402(f) notice is not very useful, noting only that the nonspouse beneficiary will have to receive RMDs from an inherited IRA.

Somehow, I (and a number of my employee benefit friends) generally managed to dance around this issue. In a number of cases, the plans simply did not offer the rollover. In other cases, the nonspouse beneficiaries elected direct payments with the amount eligible for rollover then not at issue. Other cases involved some pretty intensive communication and hand holding or the plan used the LE rule.

Now WRERA makes nonspouse direct rollovers mandatory and requires 20% withholding for direct payments. As a result, it seems that all plans will have to directly answer the basic issue of whether the RMD required by the special rule has to be paid by the plan or taken from the IRA, if for no other reason so as to get the withholding right. If the RMD is to be paid from the plan, in year 1, the 20% mandatory withholding applies only to amount of the direct payment in excess of the RMD. Conversely, if the RMD is to be taken from the IRA, the 20% mandatory withholding applies to the entire direct payment.

Comments (other than are you are insane).