Plan Rollover After Death

QUESTION: WHAT OPTIONS DOES A SURVIVING SPOUSE HAVE WHEN

(S)HE IS THE SOLE BENEFICIARY OF A RETIREMENT ACCOUNT?

Answer: A surviving spouse has the most options of any beneficiary. In order for a spouse to be able to take advantage of all of these options, the beneficiary designation form must be set up properly and the spouse must take proper steps after the death of the participant.

SPOUSE BENEFICIARY

If an individual dies while maintaining funds in an ERISA-governed plan, the individual’s spouse will be allowed to roll over the funds from the ERISA plan to an IRA in the spouse’s own name. This is called a spousal rollover. However, before executing a spousal rollover, one must ensure that the rollover makes sense from an estate planning perspective and avoids what is called the “spousal rollover trap.” The spousal rollover trap is best illustrated by the following example:

Assume Jon dies at age 47, leaving his million dollar profit sharing plan to his 47-year-old wife Patti. If Patti rolls 100% of the profit sharing plan to an IRA in her own name, any distributions will be subject to the 10% early distribution penalty, because she is under age 59½. Alternatively, if all or a portion of the funds are retained in Jon’s ERISA-governed plan or rolled over to an inherited IRA, Patti will be able to take distributions from the plan without incurring the 10% penalty.

Once a spousal rollover is done, it can’t be undone. To avoid the spousal rollover trap, a portion of the funds could be retained in the profit sharing plan or in an inherited IRA in the decedent’s name for the benefit of the spouse, if the surviving spouse is under age 59½. To determine the amount to be retained in an inherited account, Patti’s financial planner must carefully analyze her cash flow needs relative to her outside resources and qualified plan assets. In many cases, a balancing approach in this type of case is in order where one rolls over a portion of the funds and leaves the rest in the inherited IRA.

The advantage of leaving the funds in the inherited IRA is avoiding the 10% penalty on distributions because of the “death exception.” The best news for surviving spouses is that there is no deadline by which a spouse may elect to take it as his or her own. Therefore, a spouse may keep the IRA as an inherited IRA for a number of years, take distributions as required or needed, and later do a spousal rollover and assume the IRA as his or her own. In general, the advantage of rolling over the funds is that the surviving spouse can name his or her own beneficiaries and they have the opportunity to “stretch-out” distributions over their individual life expectancies.