401k/non-spousal beneficiary

Submitted by Michael Eastham on Tue, 2017-04-11 20:48

Is there a way for a non-spousal beneficiary of a 401k to rollover the inherited 401k into a beneficiary “stretch IRA” and avoid the typical rule which requires them to pay tax on the full amount over a 5-year maximum?



Submitted by Alan - IRA critic on Tue, 2017-04-11 23:11

If the plan uses the 5 year rule as the default method when participant passes prior to the required beginning date, if the non spouse beneficiary does a direct rollover to an inherited IRA by no later than the end of the year following the year participant died, the beneficiary can use a life expectancy stretch.



Submitted by Ben Meyer on Wed, 2017-04-12 00:25

Can the account be kept in the 401(k) beneficiary account for a few years if annual distributions are taken equal to the amount required by the life expectancy stretch, using the correct starting divisor and reducing by 1 each year, calculated by the beneficiary.  The first distribution would be in the year following the year of death.  Then, after 2, 3, or 4 years perform a direct rollover to an inherited IRA and continue the stretch RMD distributions with the divisor continuing to reduce by 1 each year.  This would assume that the 401(k) plan permits partial distributions.  Also assuming that the RMD equivalent distribution is taken first in the year of the direct rollover to an inherited IRA.



Submitted by Alan - IRA critic on Wed, 2017-04-12 01:10

Benn, if LE RMDs apply under the qualified plan provisions, a direct rollover to an inherited IRA would not change the RMD method.  However, some plans may still specify the 5 year rule when the participant passes prior to the RBD, and in that situation doing the direct rollover by the end of the second year is critical to avoid the 5 year rule. If the direct rollover is done after that cutoff date, the method specified by the plan carries over to the inherited IRA. See p 7&8 of Notice 2007-7 issued to clarify Sec 829 of the PPA attached which explains these rules. The applicable provisions are still valid, but what has changed is that the direct rollover is now mandatory since 2008. If a beneficiary election is indicated regarding the 5 year rule, that election must be made by the deadline. Note that these direct rollovers are only possible for designated beneficiaries and qualified trusts, not for estates or non qualified trusts. https://www.irs.gov/pub/irs-drop/n-07-07.pdf



Submitted by Ben Meyer on Wed, 2017-04-12 05:12

  • Thanks, Alan.  The key to understanding this situation is in Notice 2007-7, Q&A-19:  “… The rules for determining the required minimum distributions under the plan with respect to the nonspouse beneficiary also apply under the [rollover inherited] IRA. …”.
  • Another interesting statement in the same Notice is that a qualified plan is permitted, but NOT required, to offer a direct rollover to an inherited IRA for a nonspousal designated beneficiary or qualified trust.  (Q&A-14.)  I wonder how common are the plans that don’t offer direct rollovers following the death of the employee.
  • Some 401(k) plans apply a 5-year rule when the employee dies both before and after the RBD.  When applying the 5-year rule after the RBD, it appears that the plan desires to close the account as soon as possible, but applies a 5-year rule as an accommodation or “grace period”.  This is a 5-year rule formulated by the plan and not as a requirement of the IRC.  Any idea what rules permit a plan to design their own 5-year rule to apply after the RBD?


Submitted by William Tuttle on Wed, 2017-04-12 07:07

  • “Another interesting statement in the same Notice is that a qualified plan is permitted, but NOT required, to offer a direct rollover to an inherited IRA for a nonspousal designated beneficiary or qualified trust.  (Q&A-14.)  I wonder how common are the plans that don’t offer direct rollovers following the death of the employee.”
  • Congress was outraged by the IRS taking their explicit change to the IRC and choosing to make this voluntary on the part of the plan. There was a technical correction in WRERA 2008, that made this mandatory on the plans starting in 2010.
  • This correction was necessary, because I had a plan that was refusing to allow the rollover until it was mandated by the IRS.
  • It is mandatory now.

 



Submitted by Alan - IRA critic on Wed, 2017-04-12 17:59

Yes, many plans do not wish to deal with non spouse beneficiaries. The plans are permitted to adopt provisions that are more restrictive than the IRS 401(a)(9) requirements, but cannot adopt less restrictive measures for RMDs. Accordingly, it is possible for a plan to essentially invoke a 5 year rule for deaths after the RBD to cap the potential distribution period. Apparently, Congress did not anticipate such a provision because the special rule in A 17 of Notice 2007-7 only applies to deaths prior to the RBD. For deaths after the RBD there is no relief from a plan invoked 5 year rule and doing a direct rollover to an inherited IRA would not provide an RMD relief from this plan invoked 5 year rule, making the situation even more unfavorable to non spouse beneficiaries of such a plan.



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