The Mechanics of Revenue Ruling
2008-30
Prior to amendment by the Pension Protection
Act (PPA), a Roth IRA could only accept a rollover contribution of amounts
distributed from another Roth IRA, from a traditional or SIMPLE IRA or from a
designated Roth account. These rollover contributions to Roth IRAs are called
"qualified rollover contributions."
Under prior law, taxpayers who wanted to do a
rollover from a qualified plan had to first roll the assets from the qualified
plan to a traditional IRA, and then do a rollover from the traditional IRA to
the Roth IRA.
Under Section 824 of the PPA, however, the law
now (beginning in 2008) allows taxpayers to rollover assets directly from a
qualified plan to a Roth IRA without having to first go through a traditional
IRA.
There was no indication that this would change
the prohibition of non-spousal beneficiaries converting to a Roth IRA. Q&A 7 of Section II in Notice 2008-30, however, expands
this conversion power to non-spousal beneficiaries. Q&A 7 specifically
states as follows:
Q-7. Can
beneficiaries make qualified rollover contributions to Roth IRAs?
A-7. Yes. In the
case of a distribution from an eligible retirement plan other than a Roth IRA,
the MAGI and filing status of the beneficiary are used to determine eligibility
to make a qualified rollover contribution to a Roth IRA. Pursuant to §
402(c)(11), a plan may but is not required to permit rollovers by non-spouse
beneficiaries and a rollover by a non-spouse beneficiary must be made by a
direct trustee-to-trustee transfer.
A non-spouse
beneficiary that is ineligible to make a qualified rollover contribution to a
Roth IRA may recharacterize the contribution pursuant to § 408A(d)(6). A
surviving spouse who makes a rollover to a Roth IRA may elect either to treat
the Roth IRA as his or her own or to establish the Roth IRA in the name of the
decedent with the surviving spouse as the beneficiary. (See Notice 2007-7,
Q&A-13, for a rule on how to title a beneficiary IRA.) A non-spouse
beneficiary cannot elect to treat the Roth IRA as his or her own. (See Notice
2007-7, Part V.)
In the case of a
rollover where the beneficiary does not treat the Roth IRA as his or her own,
required minimum distributions from the Roth IRA are determined in accordance
with Notice 2007-7, Q&As -17, -18 and -19.
If this position stands, it provides remarkable
planning opportunities for beneficiaries. While the non-spousal beneficiary will
still have to begin taking required minimum distributions from the Roth IRA
during his/her lifetime, for many clients a substantial benefit continues to
exist.
Asset Protection Planning Issues - A Case
for Leaving Funds in the Qualified Plan During Lifetime
From a pure asset protection perspective, the
"exclusion" of qualified plan assets from the bankruptcy estate under ERISA
generally makes it more attractive to retain funds in a qualified plan instead
of converting the funds to a Roth IRA. This is true because the Federal
exclusion afforded ERISA plans (i.e. qualified plan assets) provides stronger
protection than the exemption protection afforded IRA assets under the
Bankruptcy Act. Further, in non-bankruptcy situations, asset protection for IRA
assets is based on uncertain and diverse state asset protection statutes, thus
strengthening the proposition that leaving assets in a qualified plan provides
superior asset protection.
Therefore, due to the increased asset
protection afforded qualified plan assets, the professional may want to consider
counseling the beneficiary about the potential benefit of leaving the funds in a
qualified plan during the beneficiary's lifetime and then having the
beneficiary's children execute a Roth IRA conversion after the beneficiary's
death.
The following section provides a summary of the
basic asset protection principles regarding qualified plans and IRA assets in
bankruptcy and non-bankruptcy situations.
The Basics of Asset Protection in
Bankruptcy: Exclusion vs. Exemption
Debtors that have filed for bankruptcy
generally have two means through which to protect their retirement plan assets
from attachment by creditors. The debtor can either seek to claim an
"exclusion" from the bankruptcy estate for their retirement assets or an
"exemption" from the bankruptcy estate.
The most favorable treatment an asset can
achieve is exclusion from the bankruptcy estate. This is because retirement
assets qualifying for exclusion are never brought into the bankruptcy estate,
and are therefore never subject to the claims of creditors.
Although less favorable, an exemption from the
bankruptcy estate may also provide creditor protection for assets in
bankruptcy. Assets which are ineligible for exclusion are included in the
bankruptcy estate, but may nonetheless find protection from creditor's claims
through an exemption.
Analysis of the Federal Laws Providing
Creditor Protection for Qualified Plans in Bankruptcy Situations
The two main bodies of federal law providing
protection for retirement plan assets are the Employee Retirement Income
Security Act of 1974 ("ERISA")
[1] and the
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("the Bankruptcy
Act").
[2]
ERISA is the primary federal law under which
retirement plan assets receive exclusion from the federal bankruptcy estate.
ERISA provides virtually impenetrable protection for assets within covered
employer retirement plans by excluding the plan assets from the debtor's
bankruptcy estate. However, ERISA protection is not all encompassing. A
retirement plan must fall under the scope of ERISA regulation in order to be
afforded its protection.
The covered employee retirement plans which are
afforded ERISA protection include 401(k) and 403(b) plans, defined benefit
plans, money-purchase plans, and profit-sharing plans. Most noticeably absent
from this list are Traditional IRAs and Roth IRAs. These retirement plans are
not covered by ERISA and are therefore not excluded from the debtor's bankruptcy
estate. However, these retirement plan assets are currently afforded protection
in the form of an exemption under the Bankruptcy Act.
The Bankruptcy Act is the second body of
federal law which confers protection upon retirement plan assets in bankruptcy
proceeding. Under the Bankruptcy Act, protection in the form of a specific
exemption is now provided for "retirement assets to the extent that those funds
are in a fund or account that is exempt from taxation under section 401
[3], 403
[4], 408
[5], 408A
[6], 414
[7], 457
[8], or
501(a)
[9] of the
Internal Revenue Code of 1986."
[10]
Therefore, even though ERISA still provides
protection for the covered retirement assets, the all encompassing provision of
the Bankruptcy Act is generally now controlling on the issue of creditor
protection for both ERISA and non-ERISA (i.e. IRA and Roth IRA) retirement
plans.
Protection Afforded IRAs in Bankruptcy
Situations
Through the Bankruptcy Act, creditor protection
is now afforded to all IRA accounts regardless of state bankruptcy laws.
Currently, unlimited exemption protection is provided for rollover IRAs and a
contributory IRA (i.e. a Traditional IRA or a Roth IRA) is afforded limited
protection in the form of a $1,000,000 exemption.
To the extent a contributory Traditional and/or
Roth IRA exceeds the $1,000,000 limitation, excluding funds from qualified plan
rollovers
[11], the
amounts above the $1,000,000 cap will not receive exclusion and will be subject
to creditor claims in bankruptcy.
Therefore, due to the $1,000,000 limitation
placed on contributory IRA protection, qualified plan accounts should not be
rolled over into or otherwise commingled with an existing contributory IRA.
Instead, the assets should be rolled into a new IRA set up specifically for the
purpose of receiving the rolled over funds.
Protection of Retirement Assets in Non -
Bankruptcy Situations
ERISA protection generally applies consistently
between bankruptcy and non-bankruptcy situations. However, protection afforded
non-ERISA retirement plan assets (i.e. IRA assets) in non-bankruptcy situations
is heavily dependent on state law.
[12] This is
because the Bankruptcy Act generally only applies to debtors who have filed for
bankruptcy. Therefore, investors in non-bankruptcy situations will need to
consult state asset protection laws for protection of their IRA assets.
