Home » Article » Retirement Plans: Non-Spouse Beneficiaries Finally Get A Break!

Spouses have always enjoyed significant tax benefits as beneficiaries of retirement plans. Non-spouse beneficiaries of qualified plans have been hit the hardest. The Pension Protection Act of 2006 now gives non-spouse beneficiaries of qualified plans a signficant tax break.

Under prior law, most qualified plans (401(k), 403(a), 403(b) & 457 plans) required a beneficiary to take immediate distribution of retirement proceeds from the plan upon the participant’s death. The surviving spouse of the participant is able to rollover those proceeds into an IRA and defer taking distributions (and consquently defer tax) until reaching age 70-1/2. Non-spouse beneficiaries, however, were not allowed the spousal rollover and were required to pay ordinary income tax on the full distribution in the year received, whether they wanted to or not. For example, assume that husband had a 401k worth $500,000 and named his wife as primary beneficiary and his children as contingent beneficaries. If husband and wife died in an auto accident, the children would have been required to withdraw the entire $500,000 immediately and pay ordinary income tax in the year of withdrawal on that sum.

The new Act, among other changes, finally gives the non-spouse beneficiary some relief in the ability to transfer the assets in a trustee-to-trustee transfer to an inherited IRA. If the participant dies after reaching age 70-1/2, distributions come out over the longer of the participant’s remaining life expectancy or the beneficiary’s lifetime. Not quite as good as the surviving spouse’s ability to defer distributions, but significantly better than immediate taxation on the entire amount. Planning Note: The plan provisions should be reviewed in light of this change. In order to realize the benefits from this change in the law, the plan must allow such a transfer.