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Inherited IRA Owners: Watch Out for These Plan Administrator Snafus

Be forewarned about how transfers and rollovers can get bungled.

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?