Planning opportunity for surviving spouse who is beneficiary of IRA and qualified plan.

Letter Ruling 9608042 describes the tax consequences of a surviving spouse's electing to roll over a lump-sum distribution from her deceased husband's qualified plan to his individual retirement account (IRA)-and not electing to treat the husband's IRA as her own.

Facts

At the time of his death, Husband was both a participant in a qualified money purchase pension plan and an owner of an IRA, and had not begun receiving distributions from either; Wife was the sole beneficiary of both the qualified plan and the IRA. Wife intends to direct the plan's trustee to transfer Husband's account balance from the plan (which permits single-sum distributions) to his IRA in a trustee-to-trustee transfer. Wife does not intend to treat the IRA as her own. She is under age 59%, and intends to begin taking distributions from the IRA immediately.

No Tax on Direct Rollover 

Sec. 402(c) (1) states that if any portion of an eligible rollover distribution from a qualified plan is transferred into an eligible retirement plan, the portion transferred is not includible in gross income in the year paid. Under Sec. 402 (c) (9), if a distribution attributable to an employee is paid to the employee's spouse after the employee's death, Sec. 402(c) applies to the distribution just as if the spouse were the employee, except that the spouse can transfer the distribution only to an IRA or individual retirement annuity.

In Letter Ruling 9608042, the IRS first noted that under proposed regulations, Wife may elect to treat Husband's IRA as her own--but that rolling over a distribution from Husband's qualified plan into an IRA will not, by itself, constitute an election to treat the IRA as her own. Thus, Husband's IRA would continue to be maintained in Husband's name, because Wife will not affirmatively elect to treat the IRA as her own. The IRS concluded, however, that the transaction will still fall within the scope of Sec. 402 (c) (9). Thus, the distribution from Husband's qualified plan to his IRA is excludible from Wife's income as a direct rollover from a qualified plan to an IRA under Secs. 402(c) (9) and 401 (a) (31).

No Excess Contributions Excise Tax 

The Code imposes for each tax year a 6% excise tax on the amount of excess contributions to an IRA. The amount of excess contributions generally is the excess of contributions for the year over the amount allowable as a deduction under Sec. 219. But in calculating excess contributions, rollover amounts are not taken into account. Because the Service had already found that Wife's proposal to transfer the distribution into Husband's IRA is a rollover within the scope of Sec. 402(c) (9), the IRS concluded that the amounts transferred to Husband's IRA from his qualified plan will not be an excess contribution.

No Penalty on Distributions Before Age 591/2

Sec. 72(t) generally imposes a 10% additional tax on taxable amounts a taxpayer receives from a "qualified plan." Sec.72(t) (2) (A) lists several types of distributions not subject to the 10% additional tax, including distributions made on or after the date the taxpayer attains age 59 1/2 Wife cannot rely on that exception because she intends to take distributions from the IRA before attaining age 59 1/2 There is, however, another exception for distributions to a beneficiary on or after the employee's death (Sec.72(t) (2) (A) (ii)).

In this letter ruling, Wife will receive a distribution from Husband's plan, contribute the distribution to Husband's IRA as a rollover, and begin receiving distributions from Husband's IRA. The Service determined that in those circumstances, even after the rollover, she does not become the IRA's owner, but remains the IRA's beneficiary for purposes of Secs. 72 and 402. Thus, the 10% additional income tax will not apply to distributions Wife takes before age 59 1/2, since those distributions will be treated as having been made to a beneficiary on or after the employee's death.

Distribution Rules

Sec. 401(a)(9) and the regulations thereunder provide rules for determining required distributions from qualified plans; Sec. 408(a) (6) provides that, under regulations, rules similar to those of Sec. 401 (a) (9) apply in determining required distributions from IRAs.

Sec. 401 (a) (9) (B) and the regulations thereunder provide rules for determining required distributions when an employee dies before his entire interest in a plan is distributed For distributions not begun before the employee's death, distributions to the designated beneficiary generally may be paid over the life or life expectancy of the beneficiary and generally must begin no later than one year after the employee's death (Sec. 401 (a) (9) (B) (iii) ). An exception applies if the designated beneficiary is the surviving spouse; distributions need not begin until the date the employee would have reached age 70 1/2 (Sec. 401 (a) (9) (B) (iv)).

The Service concluded that, because Wife will not elect to treat Husband's IRA as her own, she remains the beneficiary of the IRA for Sec. 401 (a) (9) purposes. Thus, distributions from that IRA will be subject to the distribution rules of Sec. 401 (a) (9) (B) (iii) and (iv).

Planning Opportunity

This ruling highlights a post-mortem planning opportunity available whenever a deceased employee was both a qualified plan participant and an IRA owner, and the employee's spouse is the beneficiary of both arrangements. Choosing to roll over a single-sum distribution from a deceased employee's plan to the employee's IRA and to continue maintaining the IRA in the deceased employee's name can save the surviving spouse the 10% additional tax on early distributions if the survivor needs access to the funds before reaching age 59 1/2. As the ruling shows, choosing that option will also affect the timing of required distributions.

Of course, not all the planning is post-mortem. To keep open all the options illustrated, the employee must have an IRA in existence at the time of his death.

FROM PETER I. ELINSKY, CPA, J.D., LL.M., AND DENIS L. YURKOVIC, J.D., WASHINGTON, D.C.