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Inherited IRA Owners: Watch Out for These Plan Administrator Snafus

Be forewarned about how transfers and rollovers can get bungled.

Natalie Choate, 02/12/2016

Are the rules for inherited retirement benefits too complicated? Apparently they are, judging by the number of plan administrator horror stories I hear. Here is a sample just from the last few months.

Death of beneficiary does (not!) cancel RMDs. "A" died in Year 1, leaving his IRA to "B" as designated beneficiary. Since B was not the surviving spouse of A, B was required to start taking required minimum distributions (RMDs) from the account in Year 2. Everybody knows that, right? Apparently not. B died early in Year 2, before the account had even been set up in B's name as an inherited IRA. The IRA provider told the family that no minimum distribution was required at all for Year 2 because B had died. Just for the record, that is NOT true.

No beneficiary rollover for see-through trusts? Code section 402(c)(11) has been with us in its present form since 2010. Code section 402(c)(11) clearly states that when qualified retirement plan death benefits are payable to a "designated beneficiary" other than the surviving spouse, the plan MUST offer the designated beneficiary the option of having the benefits transferred directly into an inherited IRA. This is called the "nonspouse beneficiary direct rollover." It's not an optional frill that a plan can choose to offer or not. The plan MUST carry out the direct rollover if requested by the designated beneficiary.

Yet some plan administrators still think this is optional. Recently, "C" died, leaving his qualified plan benefits to the "D" Trust. The D Trust qualifies as a see-through trust, and therefore it is a designated beneficiary, and therefore it is entitled to a direct rollover of C's plan benefits into an inherited IRA. But the administrator of C's retirement plan told the trustee it doesn't do direct rollovers for trusts--only for individual beneficiaries!

No life expectancy payout for trusts? Trusts seem to throw off some administrators. "E" died leaving his IRA to a trust. The trust qualifies as a see-through trust. However, the IRA provider (a major financial company) informed the trustee that it "never" allows a life expectancy payout to a trust. The only options available are a lump sum distribution or five-year payout!

Transferring an IRA on trust termination. Some IRA providers still do not allow fiduciaries to transfer inherited IRAs out of the trust that was named as beneficiary to the individuals who are beneficiaries of the trust. The Tax Code allows such transfers (in my opinion), and the IRS has approved such transfers in dozens of letter rulings, but the IRS hasn't really helped us here because it has never issued a Revenue Ruling or regulation specifically on this point. Therefore some IRA providers won't allow such transfers unless the trustee gets a private letter ruling.

My least favorites are the IRA providers who say they will allow the transfer but only if the trustee gives them a "hold harmless" agreement. I wonder what good the giant-financial-institution-IRA-provider thinks it will do it to have a "hold harmless" agreement from some tiny family trust or its late customer's widow and orphans. Is that really a way to treat your customers--tell them you're going to do something you think is wrong and they'll have to pay for it if you get in trouble?

I've got a better idea: The trustee should transfer the inherited IRA, still in the name of the trust, to one of the IRA providers that happily and readily allow such transfers based on their own reading of the law and the documents!

The happy ending. I do hear good stories, too: Yes, Virginia, there are some IRA providers who have gone out of their way to assist beneficiaries in the process of dealing with inherited IRAs. One financial giant has even established a special "Inheritors' Services Group" dedicated to serving beneficiaries. The staff has in-depth expertise in inherited retirement benefits and every day helps their customers' families take advantage of the tax benefits offered by inherited IRAs. A great example for the industry!

Where to read more: Regarding all aspects of inherited IRAs, see Chapter 4 of the author's book Life and Death Planning for Retirement Benefits. For fast reference, purchase Denise Appleby's IRA Beneficiary Options Quick Reference Guide.

Now available in electronic edition! By popular demand, Natalie Choate's book Life and Death Planning for Retirement Benefits has been published in an electronic version. The e-book edition gives you the entire book in word-searchable format, PLUS two additional chapters (on life insurance and annuities in retirement plans) that were left out of the print edition for reasons of space. Features live links to cross-referenced book sections and most cited tax sources. Access anywhere you have an internet connection. Visit http://www.retirementbenefitsplanning.com to subscribe or learn more.

Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is a leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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