Inherited 401K – estate/trust
A 60 year old passed away without designating a beneficiary on his 401(k). He had no spouse, and his pour over designates a pass through trust, which in turn designates a single individual beneficiary (his daughter). I am the executor of the estate as well as the trustee of the trust.
Unfortunately, my understanding is that this is not a situation in which the 401(k) can be rolled over into and inherited IRA. Plan administrators are telling me that I can liquidate the 401(k) over a several years (5 yr limit per SECURE act), but that the distribution must be paid to the estate, which can then be distributed to the trust and the daughter as cash.
My question is whether there is any way to avoid paying the compressed estate tax rates, even though the 401(k) has to be liquidated into the estate first before distribution. Is there a way to structure the transaction so that the daughter pays tax on the distribution at her income tax rates and the tax burden is passed through?
Thanks for the help!!
Permalink Submitted by Alan - IRA critic on Sun, 2021-08-29 00:10
This illustrates a really bad estate plan, but it could be worse. In most cases, the 401k administrator will require a lump sum distribution, and not be willing to entertain either the 5 year rule, or distributions using decedent’s LE. In addition, while a qualified trust beneficiary with the trust named directly on the beneficiary clause of the plan can enable a direct rollover to an inherited IRA, passing the property into the trust by a pour over will will not work even if the trust would otherwise be qualified. The pour over does not equate to the trust directly inheriting the balance from the 401k, rather than the estate.
Uniquely, if the 401k is willing to distribute the death benefits over time, they will have to be made to the estate, the estate will have to remain open, and distributions will pour into the trust. The terms of the trust then determine which entity pays the taxes on the distributions, the trust, or the trust beneficiaries.
Permalink Submitted by Bruce Steiner on Sun, 2021-08-29 12:58
Alan is correct. You should yell and scream at the lawyer who planned this estate. The decedent could have simply left the benefits to or in trust for the daughter.
Distributions from the estate to the trust carry out income, and distributions from the trust to the daughter carry out income. The executors can take the benefits over 5 years (actually by the end of the fifth calendar year following death, so they can spread them out over six (or possibly seven by using a fiscal year) taxable years. Distributions from the estate to the trust likewise carry out income, as do distributions from the trust to the daughter. So if the estate distributes the income to the trust in the same year it receives it, and the trust does the same (assuming the trustees have complete discretion to make distributions to the daughter), the benefits will be taxable to the daughter over five (or possibly six or seven) taxable years.
If the trust is well-drafted, it will allow distributions to the daughter’s childen as well as to the daughter. If that’s the case, and if the grandchildren aren’t subject to the kiddie tax, and the daughter is willing to have some of the benefits go to her children, that will allow the income to be divided among more than one taxpayer, which may reduce the income taxes.
The lawyer handling the decedent’s estate should be doing this planning.
Bruce Steiner