The Pension Protection Act of 2006 (PPA) was signed into law by congress on August 17, 2006 designed to support the ailing federal pension insurance program and try to help protect company employee pensions which are severely under-funded. Within this tax act are IRA and plan provisions that create new retirement planning opportunities for everyone concerned about saving for their retirement.
The intent of a key provision in the PPA is to allow non-spouse beneficiaries ((like a child or grandchild) to do direct rollovers to an inherited IRA and stretch the payments from the inherited IRA over the lifetime of the beneficiary. Now, non-spousal rollovers from employer plans (401ks) into inherited IRA’s are tax-free. Beginning in 2007, a non-spouse beneficiary who inherits your 401(k) or other company plan balance can transfer that plan balance directly to a properly set up inherited IRA that can be stretched over their lifetime. This also applies when trusts are named as the plan beneficiary. The transfer must be done as a direct rollover (trustee-to-trustee transfer) from the plan to an inherited IRA though. Before this, a non-spouse beneficiary who inherited a company plan would usually end up having pay tax on all of those funds in a few years and the stretch IRA opportunity would be lost. Be careful…This has to be done correctly or else the benefit will be lost and the inherited funds will be immediately taxable!
Before PPA 2006, a non-spouse beneficiary, including a trust, could not take distributions out of an employer plan other than by taking a taxable distribution, with many plans having five-year plans. Under a five-year plan, the entire plan balance had to be withdrawn by the end of the fifth year following the year of death. There were no required distributions in years one through four, but by the end of year five, the entire balance should have been distributed, and taxed. This distribution would result in the loss of any extended payouts to the non-spouse beneficiary or trust beneficiary (the stretch). If the employer plan allowed a life expectancy payout, then there was no problem and the beneficiary did not need the relief provision in PPA 2006. In that case, the beneficiary took lifetime distributions from the employer plan. There was also no problem for a spouse beneficiary, since a spouse can do a rollover and move the inherited plan funds to his or her own IRA.
The new provisions allow a non-spouse beneficiary, including a qualifying trust, the ability to do a direct rollover (a trustee-to-trustee transfer) of inherited employer plan funds to an inherited IRA. The congressional intent of the new law was to give non-spouse beneficiaries the ability to stretch distributions over their own life expectancies after the funds were in the inherited IRA, just as if they had inherited an IRA rather than an employer plan.
Be sure to get it right: The notice says that a plan does not have to allow the non-spouse beneficiary a direct transfer option, which could diminish the intended impact. If a plan amendment is required, it is unlikely a plan will allow the direct rollover provision. Non-spouse beneficiaries can avoid the plan rules that do not allow a life expectancy payout if they take the first required distribution based on the beneficiary’s life expectancy by the end of the year following the year of the employee’s death. This is
critical. If the non-spouse beneficiary doesn’t take a required distribution by the end of the year following the year of death, they will be stuck with the five-year payout rule, even though they couldn’t possibly have known the special rule didn’t exist.
Roll-Over your 401k: The many rules and complications in this IRS Notice remind us all of the reasons to always take your 401k when you leave a company, and roll those funds into an IRA as soon as you have the opportunity to do so. You always want to stay in control of your assets, and leaving them in an old companies 401k hinders that all the way from accumulation (you will have superior investment opportunities with a roll-over) through distribution which will allow non-spouse beneficiaries, such as children, grandchildren, trust beneficiaries, partners or friends to be able to stretch distributions over their lifetimes from the inherited IRA without all the bumps in the road that can occur when funds are left in the plan.
Other notable new provisions:
Tax Refunds can go to IRAs: You can direct your tax refund directly to your IRA or Roth IRA so your annual IRA contribution will be made instantly. You no longer have to wait for your refund and then make your IRA contribution.
Charitable IRA Rollovers: You can withdraw up to $100,000 from your IRA tax free and give it to a charity. You receive no tax deduction but also do not have to report the income and it satisfies your MRD. A tax infested IRA is the best asset to give to a charity.
Roth Conversions Directly from Company Plans: Beginning in 2008, you can convert company plan funds (401k) directly to a Roth IRA, eliminating the current two step process of moving plan funds into a Roth IRA. You still pay tax on the funds converted. You still must qualify for the Roth conversion, but under TIPRA legislation, in 2010 everyone qualifies for a Roth IRA conversion.
Be the expert…or hire one! Personal finance and making a retirement plan is serious business. You need to get the fundamentals down pat, spend a lifetime updating yourself on the subject, and learn the ins and outs of calculations for retirement in particular. For some reason people always think they can take short cuts with their retirement planning. The majority of people actually spend more time researching to buy a refrigerator than they do planning for their retirement! The biggest mistake one can make is to fail to educate themselves or hire a finance specialist to take care of them. Men and women, but especially men, hate to ask for directions. This is a cliché about driving, and I don’t know if it’s true or not, but it most assuredly is in personal finance.
Keith Springer is Registered Investment Advisor and President of Capital Financial Advisory Services, providing Wealth Management and Mortgage Consulting Services. For more information on how to build and maintain a solid retirement plan, please contact Keith Springer at 916-925-8900.
Sources for this publication: Internal Revenue Service, Ed Slott, CPA Rockville Centre, N.Y.,
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