401k Made out to the estate

Submitted by Mark Hilgenberg on Wed, 2011-04-06 00:42

We have a prospect who had her father pass away. He did not have an listed beneficiary and the only heir is his daughter. The 401k says a check needs to be made in the name of Estate of the deceased, and then will have daughters name on it as well as the trustee. (he did have a living trust) They said the daughter can use her social, or get an EIN from the IRS. They also stated that they withhold 20% off top for taxes.

How can she take advantage of the 5 year rule or a stretch? Would this be a inherited IRA and how would it be titled?

Thanks, Mark



Submitted by Alan Spross on Wed, 2011-04-06 02:05

Mark,
No good news here. If the plan beneficiary was an individual or even a qualified trust, the death benefit could have been directly rolled over to an inherited IRA.
Not so when the estate is the named beneficiary or default beneficiary under the plan.

Distributions will be made to the estate (or to trust per pour over will directive) until the estate or trust is terminated and the plan benefit assigned to the daughter. Plan administrators like to just cut a lump sum check and do not want to have to deal with estate beneficiaries separately. What the executor or trustee should do probably depends on whether the employee passed before his RBD or not. If prior to the RBD, the 5 year rule applies and no distributions are required before that period. If death was post RBD, then the remaining life expectancy of the employee can be used to generate a limited stretch of the death benefit and distributions should start the year after employee’s death. I do not know why the plan is stating that distribution checks will be made out to anyone other than the executor unless a pour over will is in place that sweeps everything into the trust. But that does not make the trust a direct plan beneficiary for RMD purposes, even though it would result in the trustee’s name going on the checks.

Since any distributions from the plan are not eligible for rollover, there should be NO mandatory 20% withholding. Mandatory withholding only applies to eligible rollover distributions.



Submitted by Mark Hilgenberg on Wed, 2011-04-06 14:45

Thanks Alan,

I knew the news would not be very good. He died at 56 so it was pre RBD. He did have a trust so I am assuming the trustee is added due to the pour over will. Will they just open a individual account to deposit the check, or an account in the name of the trust? Either way is the 5 year rule an accounting thing or does she actually remove funds once a year for 5 years.

The withholding is odd, I wonder if she can protest that. If not would using the 5 year rule get her some of it back via a refund?

Thanks!



Submitted by Alan Spross on Wed, 2011-04-06 19:34

The 5 year rule can turn out to be nearly 6 years if employee died early in the year. It is totally flexible regarding when distributions are actually taken, with the only requirement being that the account is completely drained by the end of the 5th year following the year of death. Taking nearly equal distributions over 6 years may reduce the tax impact as compared to waiting until the end of the period.

The actual distributions must be made to the trust until the trust is allowed to terminate or the IRA can be assigned to the trust beneficiaries. The TIN on the 1099R will be a trust EIN until, but when allowed to be paid to the beneficiaires directly, the bene SSN would be listed.

I would challenge the withholding. Since the vast majority of 401k plan distributions are now eligible for rollover, the administrators probably treat them all that way out of habit. Or they may incorrectly think that these distributions are eligible for rollover, but according to Notice 2007-7 they are not.



Submitted by Bruce Steiner on Wed, 2011-04-06 21:23

By using a fiscal year, it may be possible to spread the income over 7 taxable years.



Submitted by Mark Hilgenberg on Mon, 2011-04-11 18:33

The issue I am running into is it sounds like in order to do the 5 year rule the money needs to stay in the plan, is that the case?

If not, how do we title the new account to take advantage of the 5 years rule?



Submitted by Alan Spross on Mon, 2011-04-11 19:15

You are right. To use any stretch benefit, even the restricted 5 year rule, amounts need to stay in the IRA longer or at least until they are desired or required under the 5 year rule.

The title on the inherited IRA account is not affected by the RMD requirement. IRA custodians have system generated requirements for the titling of inherited IRAs, and they may not want to show both the estate and the trust on the registration, and they also need to show the name of the decedent. But distributions become taxable in the year distributed, so if you want to use most of the 6 taxable years, only 1/6 of the balance at the most should be requested as distributions in any year. Of course, they can also wait until the last year if there is some advantage to that based on the circumstances of the trust beneficiaries.



Submitted by Mark Hilgenberg on Mon, 2011-04-11 19:55

[quote=”[email protected]“]You are right. To use any stretch benefit, even the restricted 5 year rule, amounts need to stay in the IRA longer or at least until they are desired or required under the 5 year rule.

The title on the inherited IRA account is not affected by the RMD requirement. IRA custodians have system generated requirements for the titling of inherited IRAs, and they may not want to show both the estate and the trust on the registration, and they also need to show the name of the decedent. But distributions become taxable in the year distributed, so if you want to use most of the 6 taxable years, only 1/6 of the balance at the most should be requested as distributions in any year. Of course, they can also wait until the last year if there is some advantage to that based on the circumstances of the trust beneficiaries.[/quote]

Thanks Alan but this is at a 401k custodian and with no beneficiaries they are sounding like they want to pay it out this year.



Submitted by Alan Spross on Mon, 2011-04-11 21:03

Sorry, I did not go back to the beginning to see that this was a 401k. Yes, the funds must stay in the 401k for the full 5 year rule to be used. They cannot do the transfer to an inherited IRA because the estate was the plan beneficiary, not a qualified trust or individual. The pour over will (if there was one) does not change this fact.

The plan itself can insist on a lump sum distribution in this case and probably will, as it is their prerogative to do so. They could also allow the estate to use some or all of the 5 years if they wanted to, but most plans want to do a lump sum distribution and be done with it. There is probably nothing that can be done here if the plan insists on a lump sum distribution. This is a good example why estates should not be listed as beneficiaries of retirement plans.



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