401k distribution – estate with no beneficiary

Submitted by Thomas Bickett on Tue, 2019-07-16 21:00

Hi all,

My grandmother passed away last year and left a 401k with no designated beneficiary. The 401k manager required the estate to liquidate the account. The executor of the estate recently distributed the funds from the 401k (the end of the estate tax year is 31 July) to heirs. The amount received was less than expected, and when I inquired with the estate executor he indicated that a 20% tax was imposed on the account balance upon its liquidation, and that I should take a credit in that amount when filing my taxes. My question is should the estate have deferred/declined that tax withholding and simply passed the tax on to the heirs? Or does it make no difference whether the taxes were taken upon liquidation of the account, as long as a credit for the taxed value can be taken by the heirs?

Thank you for your help.



Submitted by Alan - IRA critic on Tue, 2019-07-16 23:35

There is no mandatory withholding for such a distribution because it is not eligible for rollover. Did the executor ask for this?  It will be a hassle for the executor because the withholding credit cannot be passed through to the beneficiaries on a K 1. The estate will receive a refund from the IRS and will have to apportion it to each beneficiary. It is usually preferable to clearly decline withholding when possible and let each beneficiary pay their own estimates on the taxable distributions from the estate.

Submitted by Thomas Bickett on Wed, 2019-07-17 12:35

Thanks for the reply! I am thinking the executor is not clear on the rules.  1) He told me that witholding at the time of account liquidation was mandatory, and he had no say in the matter.  Is it possible that the fund manager could have something in their distribution rules that requires it be withheld?  2) He also seems to think that he can pass the witholding as a credit to heirs through a K-1 (or some other form) because he has made no mention about having to redistribute the witholding upon receiving an IRS refund. And please excuse my ignorance here, but when you say it would have been better for the beneficiary to “pay their own estimates on the taxable distributions,” is there a requirement for the heirs to estimate their tax payments and pay the estimate prior to normal filing time?  Or is it acceptable to file normally with the taxable distribution as income and pay at that time?  Thanks again. 

Submitted by Alan - IRA critic on Wed, 2019-07-17 15:13

A beneficiary can avoid any underpayment penalty by meeting one of the safe harbors, the common of which is paying in 100% of the prior year tax liability (110% for higher earners). If so, even though the beneficiary would owe taxes on all the additional income in April, there would be no penalty. On the other hand, if a beneficiary has not done this with the first two quarterly estimates, they would have to file a 2210 AI and pay a much higher estimate in the quarter they receive their share. Unfortunately, the withholding that was taken is estate withholding and cannot be simply transferred to the beneficiaries. As for the plan administrator, they might have an internal rule requiring withholding for all distributions, but the IRS’ mandatory 20% withholding does not apply to distributions that are not eligible for rollover, and this distribution is not eligible. You are right that the executor is missing some key points. I don’t know if there is any recourse available against the plan for withholding in error. Eventually, it will equal out but will result in a more complex 1041 and hassle for the executor. Suggest he contact a tax preparer well experienced in 1041 preparation to verify this, secure guidance, and probably file the 1041 when applicable.

Submitted by Thomas Bickett on Wed, 2019-07-17 15:23

This is very helpful. Thank you for providing this info.

Submitted by Thomas Bickett on Fri, 2019-10-18 16:02

First, thanks for the prior information related to my question. I’m bringing it back up in the hopes you can point me to some IRS language that I can pass to the estate executor, because they still seem to be trying to handle this incorrectly.
1) Alan, you indicated that there is no mandatory 20% withholding at time of of liquidation for an account not eligible for a rollover – Another thread pointed me to notice 2007-7 to confirm that an account with no designated beneficiary is not eligible for rollover – could you tell me a) what part of 2007-7 indicates that an account with no designated beneficiary is not eligible for rollover and b) language that states accounts not eligible for rollover are not subject to mandatory withholding?
2) You indicated that the 20% withholding can not be directly transferred to heirs as a credit on the K-1, rather it must be refunded to the estate, and then additional distributions must be made to the heirs (correct me if I misread). Is there any language stating that this is the method that should be used?
I ask both questions b/c the estate is intent on waiting to file their taxes for the year, then issue the heirs a K-1 with a credit for the 20% withholding. If I can get them to either go back to the fund manager and contest the withholding, or at least distribute the withholding using the correct process, I might be able to avoid more headaches.
Thanks again.

Submitted by Alan - IRA critic on Fri, 2019-10-18 17:36

  • Q 2 -Sec 3405(c) indicates that eligible rollover distributions are subject to mandatory 20% withholding. Sec 3405(b)(1) indicates that non periodic distributions (such as the distribution of a 401k to an estate) is subject to default withholding of 10%, however Sec 3405(b)(2) also indicates that a taxpayer can elect NOT to have paragraph 1 apply. Therefore, no withholding can be elected. In this case the plan used the wrong withholding rate and apparently did not give the estate the option of electing 0 withholding.
  • With respect to withholding on distributions paid to the estate, the 1041 Inst p 27 indicate –  “Except for backup withholding, withheld income tax may not be passed through to beneficiaries on either Sch K-1 or Form 1041-T”

Submitted by Alan - IRA critic on Fri, 2019-10-18 17:10

  • This portion of Notice 2007-7 has been incorporated into the tax code – Sec 402(c)(11) copied below. Note that this is limited to designated beneficiaries, which are limited to individuals by definition. An estate is not a designated beneficiary, so the distribution is not eligible for rollover.
  • (11) Distributions to inherited individual retirement plan of nonspouse beneficiary(A) In generalIf, 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,        

Submitted by Thomas Bickett on Fri, 2019-10-18 18:08

Thanks so much – I wouldn’t have possibly been able to come up with all of that on my own.

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