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4 Dumb Answers About IRAs and Retirement Plans

Natalie Choate shares some of the incorrect statements she's heard from IRA providers and plan administrators.

As a professional advisor helping clients with their IRAs and retirement plans, you meet your share of plan administrators who don't know what they're talking about. Here's a collection of erroneous statements that advisors have heard from IRA providers and plan honchos over the years--all true stories. When you hear one of these bloomers, you know the "expert" you're speaking with is talking through his or her hat.

From a 401(k) administrator to a deceased employee's son who was named as beneficiary of the plan: "We can't roll these death benefits to an IRA for you. All we can do is give you a lump sum distribution check." Wrong! Since 2009, qualified retirement plans have been required to offer the option of a "direct rollover" of death benefits to an inherited IRA for the designated beneficiary. This plan administrator needs to catch up with that law change.

From an IRA provider to the executor of an estate that was the beneficiary of a decedent's IRA: "Since the decedent did not name a 'designated beneficiary,' the law requires you to take all the money out of the IRA within five years." But the IRA owner had died at age 73--after he started taking required minimum distributions. The "five-year rule" applies only in cases of death before the "required beginning date," that is, before the IRA owner or employee was required to start taking his lifetime RMDs. When a person dies after his required beginning date without having named an individual "designated beneficiary" to inherit the account, the five-year rule doesn't apply. Instead, the remaining account balance must be distributed in annual installments over what would have been the deceased owner's remaining life expectancy (or more rapidly--that's the slowest rate it can be distributed). In this case, the deceased IRA owner's life expectancy under IRS tables would have been about 14 years--much longer than the five-year payout the IRA provider was trying to apply.

The ability of a surviving spouse to "roll over" benefits that are paid to her directly as named beneficiary is well known. Less well known is that the IRS allows the spousal rollover even if the benefits are paid to the spouse indirectly, through an estate or a trust--provided the spouse has the right to take the money out of that estate or trust. Since this IRS policy is (so far) established only through private letter rulings, it's understandable that plan administrators may not go along with it ... but some plan administrators can mess up even an understandable refusal. I've heard this story more than once.

From a plan administrator to a surviving spouse: A decedent's 401(k) benefit is payable to his estate. The spouse is the sole beneficiary of the estate. She asks the plan to transfer the decedent's account directly to her IRA (spousal direct rollover). The plan refuses because she is not the named beneficiary. OK, that's understandable. But then they say to the spouse: "You are not entitled to roll this money over because you're not the named beneficiary. So the only way we will pay out this benefit is by writing a check to you personally. And we have to withhold 20% federal income tax from that check."

No! Withholding of income tax is supposed to occur with almost all retirement plan distributions, but the recipient can usually "opt out" of that withholding. Mandatory income tax withholding applies to only one kind of distribution, the "eligible rollover distribution" from a qualified retirement plan. If the recipient of a qualified plan distribution (whether he/she is the participant or the beneficiary) has the option under the statute to request a direct rollover of the distribution to an IRA (or inherited IRA), but instead takes cash (opts out of the direct rollover), the plan must withhold 20% from the check, and the recipient can't opt out. But this plan is telling the spouse she does not have the option of a direct rollover, and the plan still insists on withholding 20%. The plan is way off base. Either let her do the direct rollover, or give her a check with no withholding--you can't have it both ways.

Finally, here's an example from an IRS agent. When his client was being audited regarding IRA distributions, the advisor pointed out to the IRS agent a regulation proving the advisor was right. But the regulation (one of the minimum distribution regulations under section 401(a)(9)) said it applied to "the employee." The IRS agent said to the advisor, "The regulation you've cited only applies to employees and we are dealing with an IRA owner here, so that regulation doesn't apply." Please send this IRS agent back to school, and have him read Reg. § 1.408-8, A-1(b), which says that the qualified plan minimum distribution regulations are applicable to IRAs as well as plans, with "the IRA owner" being substituted for "the employee" in the text.

It's frustrating to deal with "people in power" who don’t know the rules as well as you do.

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.