Employer Retirement Account Being Paid to Spouse of Employee Cannot be Transferred to Inherited IRA of Spouse's Beneficiary at Spouse's Death

A surviving spouse was being paid out of an employer sponsored retirement plan based on an account held by the now deceased spouse.  In Information Letter INFO 2017-0030 the IRS addressed the question of whether, now that the surviving spouse had passed away, the balance of the account could be transferred to an inherited IRA for the benefit of a beneficiary of the surviving spouse.

IRC Section 402(c)(11) allows for a rollover of an employer retirement account balance as outlined below:

(11) Distributions to inherited individual retirement plan of nonspouse beneficiary

(A) In general

If, with respect to any portion of a distribution from an eligible retirement plan described in paragraph (8)(B)(iii) of a deceased employee, a direct trustee-to-trustee transfer is made to an individual retirement plan described in clause (i) or (ii) of paragraph (8)(B) established for the purposes of receiving the distribution on behalf of an individual who is a designated beneficiary (as defined by section 401(a)(9)(E)) of the employee and who is not the surviving spouse of the employee—

(i) the transfer shall be treated as an eligible rollover distribution,

(ii) the individual retirement plan shall be treated as an inherited individual retirement account or individual retirement annuity (within the meaning of section 408(d)(3)(C)) for purposes of this title, and

(iii) section 401(a)(9)(B) (other than clause (iv) thereof) shall apply to such plan.

A “designated beneficiary” of the employee is defined at IRC §401(a)(9)(E) as:

(E)Designated beneficiary.—

For purposes of this paragraph, the term “designated beneficiary” means any individual designated as a beneficiary by the employee.

The problem in this case is that the person who wishes to have a balance transferred to the IRA was not designated by the employee, but rather by the employee’s surviving spouse.  As the letter notes:

Accordingly, Section 402(c)(11) does not apply to a beneficiary of a surviving spouse or other designated beneficiary. Thus, a transfer to an inherited IRA for the benefit of a beneficiary of the surviving spouse would not be an eligible rollover distribution because the beneficiary is not a designated beneficiary of the deceased employee.

The key problem with this situation is that the surviving spouse continued to receive the benefit from the plan as a beneficiary of the deceased employee.  Had the funds been rolled to an IRA, IRC §402(a)(9) would have allowed the spouse to treat the distribution as his/her own, creating the spouse’s own IRA. 

In that case, the spouse’s beneficiary would then have received an inherited IRA, and that IRA could have been transferred in a trustee to trustee transfer to another custodian who would hold it as an inherited IRA.