Benefits and Compensation

IRS Ruling Permits Rollover from Deceased Participant’s Account to Non-Designated Beneficiary

Plan sponsors regularly handle situations that arise from a deceased participant’s failure to designate a beneficiary for his or her employer-sponsored retirement account. A private letter ruling (PLR) from the Internal Revenue Service (IRS) earlier this year could provide some insight into the agency’s thinking about allowing surviving spouses to roll over a deceased participant’s funds, even if a proper designation was not made to the spouse when the participant was alive.

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Under IRS rules, a distribution from a retirement plan formerly held by a deceased participant to a designated beneficiary may be treated as an eligible rollover with certain tax exemptions. But the same treatment generally does not hold for payout to a non-designated beneficiary.

Surviving Spouse Allowed Rollover

In PLR201821008, dated February 22, the IRS ruled a taxpayer was able to roll over a distribution from a deceased spouse’s employee retirement account into her own individual retirement account (IRA) after it was initially paid out to the decedent’s estate. The ruling was released to the public in May.

A PLR is binding for the IRS and the requesting taxpayer (in the event the matter is further disputed or litigated), but only for those parties. Thus, a PLR may not be cited or relied upon as precedent by other taxpayers.

The decedent participated in an eligible 457 deferred compensation plan. He died before reaching age 70½, the plan’s age of distribution. He did not designate a beneficiary, so his estate became the account’s beneficiary. The account’s proceeds were distributed to the estate in a lump sum and were subject to state and federal taxes after the participant’s death.

His spouse, who was his executor and the sole beneficiary of his estate, distributed the remainder of the account after taxes to herself in a traditional IRA within 60 days of the plan’s distribution.

In the PLR sent in response to a September 2017 query from the widow’s representative to the IRS, the agency concluded the taxpayer in this case can be treated as having received the distribution from the plan, which made it eligible to be rolled over into a personal IRA. The IRS said the surviving spouse in this case was not required to include the rollover amount in her gross income for federal tax purposes because she rolled over the qualifying amount within the necessary deadline.

The ruling clarified questions arising from the fact that the decedent’s estate ordinarily would be considered a non-designated beneficiary, ineligible for the same rollover benefits.

Two Important Points

The PLR highlights two important points, according to Employee Retirement Income Security Act (ERISA) attorney Paul D. Woodard at the law firm Butterfield Schechter LLP. Woodard wrote in a July 26 client bulletin that, “[f]irst, it is important to designate a beneficiary for employee retirement accounts and other benefits. Second, it is also important to update the beneficiaries as necessary after a major life event, such as a death, divorce, marriage, or birth.”

“Failing to designate a beneficiary could result in costly tax treatment or tax litigation with the IRS,” as this case’s query and concerns posed to the IRS indicated, Woodard said.

Jane Meacham is the editor of BLR’s retirement plan compliance publications. She has nearly 30 years’ experience as a writer/editor of financial services news.