Inherited 401K/Inherited IRA
In 2019 a gentleman passed away at the age of 58. He had a 401K and his brother who was 66 at his date of passing, inherited the 401K. No RMD’s were taken in 2020 due to the CARES act. The custodian is using Table I factors to calculate RMD’s for the beneficiary, but states the account must be emptied by 12/31/2024.
Every plan has different rules, but this plan allows it to be rolled over to an Inherited IRA. Since the decedent passed away before the passage of the SECURE Act, does this allow his beneficiary to have a Stretch IRA? I am a little confused because of the Inherited 401k component.
Permalink Submitted by Alan - IRA critic on Thu, 2021-10-28 15:11
If you are sure that the brother was directly named on the plan as beneficiary, the 5 year rule might be explained by the plan using the 5 year rule instead of life expectancy as the required method for deaths prior to RBD. However, that does not explain why an annual RMD is being distributed in 2021. Per Notice 2007-7 QA 17 (special rule), if the plan default is actually the 5 year rule, the beneficiary could avoid that by doing a direct rollover to an inherited IRA by the end of the year following the year of death. That deadline was missed, so the 5 year rule would apply whether a direct rollover to an inherited IRA is done now or not. And if the 5 year rule would have applied, the 2020 waiver of RMDs also allows 2020 to not be counted under the 5 year rule, meaning that the account would not have to be drained until 12/31/2025. Apparently, the CARES Act did NOT include ignoring 2020 for purposes of extending the deadline by 1 year for a direct rollover to erase the 5 year rule.
Therefore, the plan administrator should be asked to explain if the plan defaults to the 5 year rule for deaths prior to RBD, and if so why annual distributions are being made, and also why 2020 was counted under the 5 year rule. Also, to verify that brother was named and participant’s estate did not inherit the plan. There are too many inconsistencies here to be explained before resolving this.
Permalink Submitted by Robert Roselli on Thu, 2021-10-28 15:52
I will confirm if the brother or the estate was the beneficiary. Since the decedent passed away prior to his RBD date, are the rules different if his brother is named the beneficiary vs. the estate? It sounds like if they are using the 5-year rule, then annual RMD’s shouldn’t be required. I’m a bit confused as you mentioned that the 2020 waiver of RMD’s allowed 2020 to not be counted toward the 5-year rule, but then said the CARES act did not include that provision. Is 2020 counted as a year or can we skip it? Thanks as always for your valuable input in some of these unique sitations.
Permalink Submitted by Alan - IRA critic on Thu, 2021-10-28 16:14
If the 5 year rule applies and 2020 is one of the 5 years, you skip 2020. However, the CARES Act which provided this exception did not extend to skipping 2020 for purposes of providing an additional year for a direct rollover to an inherited IRA to be used to escape the 5 year rule. So IF the 401k used the 5 year rule, it would end in 2025, but the deadline to avoid the plan 5 year rule by direct rollover was 12/31/2020 because for that particular deadline CARES provided no relief. That direct rollover deadline was not extended to 12/31/2021. Therefore, if the plan requires the 5 year rule, there is no way to escape it now. This is different from the end date of the 5 year rule itself, which should be 12/31/2025.
If brother was named directly on the 401k, he could use his life expectancy for annual RMDs, which is much better than the 5 year rule or the 5 year rule with one extra year to 2025.
Permalink Submitted by Robert Roselli on Fri, 2021-10-29 15:19
My client sent me the distribution paperwork that was filled out at the time. He had two choices, to elect the entire balance by the 5th anniversary of the client’s death or to elect RMD’s. He chose to have the entire benefit disbursed by 12/31 of the 5th anniversary of the client’s death. In the next section, he elected to have RMD’s every year on September 20th. I didn’t get confirmation that he was named the beneficiary, but if it was the estate, I imagine it wouldn’t have given him a choice.Since he elected the 5-year payout, it sounds like we are stuck with it, because we had until 12/31 of the year following the death of the decedent to change it. That deadline was 12/31/2020. Do you think we should still confirm who the beneficiary was? And does help clarify what we need to make a final determination?
Permalink Submitted by Alan - IRA critic on Fri, 2021-10-29 15:52
The paperwork makes sense. SInce the choices reflect that there was a named beneficiary and he thinks so as well, no need to verify that again. He cannot get out of the 5 year rule now, but if interested, he could point out that the 5 years should now end in 2025 due Sec 2203 of the CARES Act. The annual distributions he is getting now could be reduced due to the extra year, and these are not RMDs since under the 5 year rule, there are no annual RMDs, just the requirement that the account be drained by the end of the 5 year period (which should be 2025 in this case).
The custodian is probably distributing annual RMDs because of an error made by the IRS in the spring in Pub 590A. That error has been corrected by the IRS now, and there are no annual RMDs under the 5 year rule or 10 year rule. Further, Secure does not not even apply to deaths in 2019. That said, it is usually beneficial to withdraw amounts equally each year (eg 20% of the balance this year, 25% next year, 33% following year, then 50%, and in 2025 the balance) to prevent a large tax bill for the final year. Of course, if he is happy with the current arrangement, he could just leave it as is. He can take out any amount he wishes until 2025.
Permalink Submitted by Robert Roselli on Fri, 2021-10-29 16:17
Thanks for the clarification. Prudential (current custodian) said it can be transferred wherever they want, which will be TD Ameritrade. The same rules will apply, but they can have the money with us until 12/31/2025. What mechanisms are in place to ensure that the account will be drained by 12/31/2025? If he leaves it where it is, it’s in the plan document and they have the paperwork. But what trigger will TDA have to ensure it’s emptied by 2025. Of course, we will keep track of it, but what if the client moved it over to TDA retail and didn’t tell us. Would TDA have a mechanism to know it needs to be emptied by 12/31/2025?
Permalink Submitted by Alan - IRA critic on Fri, 2021-10-29 18:05
The beneficiary is responsible for communicating the situation and/or the RMD requirements to any new IRA custodian receiving the account by direct rollover, but the custodian may not even be interested. It’s up to the beneficiary to request whatever distribution amounts desired each year and to be sure the inherited IRA is drained by the end of 2025. An IRA custodian will not force out a distribution, the beneficiary must request it.
Permalink Submitted by Robert Roselli on Fri, 2021-10-29 18:28
Thanks for all these very detailed answers. This was a huge help.
Permalink Submitted by Robert Roselli on Wed, 2021-11-17 15:32
We correpsonded about a case a few weeks back where the beneficiary has until 12/31 of the year following the death of the decedent to roll it over to an IRA and use life expectancy instead of the 5-year rule. I have a different case where a guy died on 1/1/20 and his estate is the beneficiary. The funds went to his brother and his brother just sent me a letter confirming that he until 12/31/26, not 12/31/25 because of the CARES act. Can he opt of this by 12/31/21 since it’s within the time frame, or are the rules different because in this case, the estate was named and not his brother directly?
Permalink Submitted by Alan - IRA critic on Wed, 2021-11-17 19:18
The 5 year rule only applies if the decedent passed prior to his RBD. In that case, the end of the 5 year rule is 12/31/2025, not 2026. While 2020 is not counted when it is one of the 5 years, the year of death (2020) is not one of the 5 years. The first year of the 5 year period is 2021. Whoever told the brother he had to the end of 2026 was incorrect. That extra year was only for deaths between 2015 and 2019. Since the estate actually inherited the IRA, the assignment of the IRA out of the estate to the brother does not change the applicability of the 5 year rule, it just allows the estate to close and the brother has his own inherited IRA to manage. Since the owner passed in 2020, there is no year of death RMD for the estate or his brother to be concerned with.
Permalink Submitted by Robert Roselli on Wed, 2021-11-17 19:49
The decedent had a 401k with vanguard. He was 56 at the time of his passing. He didn’t have any beneficiaries. His brother set up an Inherited 401k and the plan is still with Vanguard. It makes sense that 2025 is the last year to take money out not 2026. The plan will allow him to roll it over to an Inherited IRA, With the estate being the beneficiary, does that rule apply that he has until 12/31 of the following year to get out of the 5-year rule or is that only for Inherited 401k’s where there is a named beneficiary?
Permalink Submitted by Alan - IRA critic on Wed, 2021-11-17 21:19
Since the estate was the beneficiary, under IRS rules the plan is not eligible to be rolled into an inherited IRA. There must be a designated beneficiary (brother would have had to be directly named as beneficiary, and would have been a designated beneficiary with an age). An estate is not a designated beneficiary, so cannot be rolled over to an inherited IRA. Most plans would require a lump sum distribution for estate beneficiaries, so brother is fortunate that this plan may agree to allow partial distributions and avoid a lump sum distribution until the 5th year. None of this changes the 5 year rule period.
As you last stated, there is no way out of the 5 year rule when the estate is the beneficiary. There might have been in an individual beneficiary was designated.