Hi, Gail-
I read someplace (maybe your column) that if you inherit a company retirement plan you don’t have to cash it out anymore. Instead, you can roll the money into an IRA and let it sit there until you are 70½. Have I got this right?

My 82-year old aunt recently passed away and I ended up inheriting her 401(k) because my uncle (who was her primary beneficiary) died a few years ago.

It’s a decent amount of money — about $134,000. But since I’m working, I don’t need it right now. I’d much rather let it grow so I’ll have it for my own retirement.

Can you please tell me if I’ve understood this new law correctly?

Thanks,
Gerald

Dear Gerald,

You’re smart to check. Your information is only partly correct and if you don’t do this exactly right, you’ll miss a significant opportunity.

The Pension Protection Act (PPA) enacted last year extends to non-spouse beneficiaries a privilege that until recently was only allowed spouses: the ability to move money from an inherited company retirement plan to an IRA.

There is still, however, a crucial difference.

If you were the spouse of the decedent, you could “roll” the money into an IRA in your own name. At that point, it becomes “your” IRA. As the IRA owner, you have the power to change the beneficiaries on the account and postpone taking any withdrawals until you turn age 70½.

However, since your relationship to the owner of the 401(k) account was “nephew,” as opposed to “spouse,” you are not allowed to transfer the money into your own IRA.

Instead, the IRA would be opened in the name of the deceased person (your aunt) and you would be listed as the beneficiary of this account. This is generally called either a “beneficiary” or “decedent” IRA.

The important point is that — as strange as this sounds — in the eyes of the law, the deceased person is technically the “owner” of this IRA.

As a non-spouse beneficiary of an IRA, you must begin taking what are called “Required Minimum Distributions” (withdrawals) from this account no later than December 31st in the year after the account owner died. These will be based on your life expectancy.

In other words, you cannot postpone withdrawals until you are ago 70½. However, any money that remains in the beneficiary IRA will continue to be sheltered from income tax until it is withdrawn. Depending upon your age, this could result in decades of continued tax-deferred appreciation.

Since your aunt died this year, the deadline for your first RMD is December 31, 2008.

Early this year the Internal Revenue Service issued regulations that explain how it interprets the language in the Pension Protection Act concerning non-spouse beneficiaries of retirement plans. Unfortunately, the I.R.S. has taken a very narrow view of how this will apply.

First, before you can move the money from your aunt’s 401(k) account into a beneficiary IRA, you need to check with the administrator of the 401(k). A 401(k) or 403(b) plan is not required by law to provide a mechanism for non-spouse rollovers.

Furthermore, the I.R.S. has taken the position that if the retirement plan doesn’t allow this type of rollover, then the non-spouse beneficiary cannot do it! (I know, I know. It seems ridiculous that your aunt’s 401(k) plan gets to dictate whether you can roll over her account, but that’s the way the I.R.S. sees it.)

It is still unclear whether the plan has to be formally amended to allow this or not.

At the very least, the 401(k) must be willing to move the money from your aunt’s account to the beneficiary IRA via what is called a “trustee-to-trustee” transfer.

If the plan is set up for this, the transfer can be done electronically, with the money going straight from your aunt’s 401(k) account to the new IRA. However, for this to work, you need to open the IRA before you submit your request for the transfer. That’s because the 401(k) will need the name of the IRA custodian and the IRA account number so that it knows where to send the money.

An alternative would be for the 401(k) to send you a check made out to the IRA — not to you! You would then deposit the check into the beneficiary IRA.

It is extremely important that the check be made out to the IRA! If the plan makes the mistake of issuing the check in your name, you lose the ability to re-deposit the money into an IRA of any type. The entire amount will have to be declared as income and you will owe tax on it this year.

Assuming you successfully navigate these hurdles, there is one additional technicality you need to comply with before your safe: the withdrawal of your first RMD.

According to C.P.A. Ed Slott, author of “The Retirement Savings Time Bomb,” the safest approach is to roll your aunt’s 401(k) entire balance into a beneficiary IRA this year, i.e. the year the account owner died. Then any time the following year (up to December 31st) you can withdraw your first RMD.

If you wait until the year after death (2008 in your case) to roll the 401(k) money, you need to withdraw the RMD first. Then you can move the remaining assets into a beneficiary IRA.

I know this sounds complicated, but if you take it step by step, you should be fine. And the result will be well worth it. By the time you stop working, the value of your aunt’s 401(k) account could be considerably higher; it may very well be a major source of income for your own retirement years.

Hope this helps,
Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.