Non-Spousal Beneficiary Allowed To Roll Over Distributed Funds To Inherited IRA
“Lydia’s” father died in 2008 when she was only 13 and he named her as sole beneficiary of his qualified plan.
Under IRC Sec. 402(c)(11) Lydia was entitled to have a direct trustee-to-trustee transfer made of the inherited qualified plan to an inherited IRA. Lydia’s mother and guardian, however, made no attempt to make a direct transfer of the qualified plan to an inherited IRA. Instead, she filed paperwork with the plan administrator to receive a lump sum distribution of the plan. Such distribution was made and the resulting taxes were paid.
A conservatorship petition was filed in the local court for Lydia’s estate and a suit was brought to contest the lump sum distribution received by the mother. Accordingly, a statement and a list of expenditures were filed by the mother in connection with these proceedings. The Court eventually ordered the mother to reimburse the distributed amount (less certain acceptable expenditures) to Lydia’s conservator because the mother had inappropriately spent the funds.
It was also ordered that the conservator seek assistance in determining whether Lydia could amend her 2008 federal and state income tax returns to recoup the taxes paid. The reimbursed amount was put in a non-interest bearing account.
The taxpayer requested the following rulings:
1) Lydia is eligible to have transferred, by means of a trustee-to-trustee transfer, within the meaning of IRC Sec. 402(c)(11), the interest in the qualified plan into an IRA set up and maintained in her own name, either with the present custodian or to a different custodian.
2) Lydia will not be required to include in gross income for federal income tax purposes for the 2008 year in which the distribution from the plan occurred and for the year in which the subsequent transfer is made pursuant to ruling number 1) above, any portion of the amounts transferred from the plan into an IRA set up and maintained in her own name.
IRC Sec. 402(c)(11) allows the post-mortem transfer of qualified retirement plans to inherited IRAs by non-spousal beneficiaries when such transfer is done via direct trustee to trustee transfer. What is not allowed, however, is for a non-spousal beneficiary to perform a 60-day rollover. When a non-spouse takes a distribution from an inherited plan or IRA, there is no provision allowing such beneficiary to place it back into the account, even if the deposit is made within 60 days. In this case, however, the IRS allowed the money to be placed back into the plan and transferred to an inherited IRA. Although the ruling states that the IRA will be set up and maintained in Lydia’s own name, the authors assume that the IRA will be set up as an inherited IRA (i.e. in the name of the father for the benefit of Lydia).
The IRS, as is usual with private letter rulings, does not go into great detail in explaining the reasoning behind allowing the distribution to be placed back into the plan. The IRS has, however, allowed restorative payments to be placed back into an IRA or plan. See PLRs 200738025 and 9507030. A restorative payment is generally a payment made to restore losses to the plan resulting from actions by a fiduciary for which there is a reasonable risk of liability for breach of a fiduciary duty. See Rev. Rul. 2002-45. In this case, the IRS may be treating the funds reimbursed by the mother as restorative payments, thus restoring the funds to the plan and making way for the allowable transfer to the inherited IRA.
This was obviously a wonderful result for the taxpayer in this case but it also gives us the opportunity to remind readers not to take a distribution from an inherited plan unless a taxable distribution is desired. As stated above, once a non-spouse beneficiary takes a distribution from an inherited plan or IRA, it generally cannot be placed back into the tax deferred account even if the distribution was an innocent mistake or unintended.
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