avoiding estate income tax on inherited 403(b) annuity

Submitted by Bruce Gordon on Mon, 2023-08-28 17:59

Sister died November, 2022, divorced, no children. She had a 403(b) tax sheltered annuity, not an NQDA. Sister named our Mom as beneficiary, Mom died 2014, no contingent or subsequent beneficiary named. Estate apparently becomes the beneficiary of the annuity? Sister’s will named other sister and me as equal heirs. Is there some process to withdraw/distribute funds from annuity, transfer annuity intact, something else, so as to avoid the estate having to pay estate income taxes?

Bruce Gordon



Submitted by Alan - IRA critic on Mon, 2023-08-28 18:30

The plan should specify a default beneficiary, but most likely in this situation it will be her estate. If she passed prior to RBD the 5 year rule applies, but when an estate inherits a qualified plan like this, the result is almost always a lump sum distribution because the plan typically will not deferral of distributions. Also, since there was no designated beneficiary, a direct rollover to an inherited IRA of the estate beneficiaries is not allowed by IRS rules. Somewhat surprising that the plan has not already distributed the balance to the estate if the estate EIN has been established and a death cert provided to the plan. When the estate receives the full distribution, the estate can pass the income out of the estate to the will beneficiaries on Form K 1 filed with the estate income tax return Form 1041. The beneficiaries will have a lower tax rate than the estate.

Submitted by Bruce Gordon on Mon, 2023-08-28 22:03

Alan, thank you!  Plan knows sis has passed, but they wanted me to defer sending Death Certificate and EIN until I complete and send the Death Claim Form, which I haven’t.  Sis passed after RBD, annuity plan is offering two (maybe a third) options:  lump sum or 5 year payout.  Plan has offered to create an Inherited Beneficiary IRA in name of sister’s estate to facilitate 5 year rule distributions.  Are you saying IRS won’t allow that?  Another option on Death Claim Forms from Plan is a tranfer.   If I (I’m executor of will)  establish an inherited IRA in deceased sister’s name fbo myself and other sister, could we do a transfer (not rollover) of all funds into that IRA, then distribute equally?  If so, what would be time limits to distribute all funds?  What might be tax consequences?   In any event, your advice re 1041 “pass thru” is encouraging.   

Submitted by Alan - IRA critic on Mon, 2023-08-28 22:48

  • There is no way to get these funds into an inherited IRA under IRS rules. This can only be done if there was a designated beneficiary (individual), and an estate does not qualify. 
  • It’s odd that they mention 5 years since the 5 year rule only applies for deaths pre RBD. As indicated, a lump sum distribution is the usual result in situations like this, and the IRS RMD rules for deaths after RBD with an estate beneficiary stipulate annual RMDs over the decedent’s remaining life expectancy, which would only turn out to be 5 years if she passed at 88 or 89. Paying out over any time period would require that you keep the estate open and file 1041 tax returns for the entire period, and you may not want to do that. 
  • Offering a direct rollover to an inherited IRA and mentioning the 5 year rule (unless this just happens to be 5 years due to sister’s age at death with 5 years left in the single life table) suggests that they are confused by these various issues. Therefore, it’s difficult to determine where they are coming from.  If they are willing to pay it out over 5 years that would help on the taxes compared to a lump sum distribution, but you would have to keep the estate open to receive those distributions. 

Submitted by Bruce Gordon on Tue, 2023-08-29 00:07

Thank you again, Alan.  Narrowing down the options.  Sis was 82 when she passed.  The Death Claim Form contains the following option, related to the 5 year payout:  “Setup a Beneficiary Account with the same contract type as the decedent.”  Then, we would have up to 5 years to distribute at whatever rate we choose.  I’m inclined to go that way, and distribute half of account this year and the remaining balance first of next year, to close account and minimize number of estate tax returns needed and reduce the time the estate would have to be kept open.    

Submitted by Bruce Gordon on Tue, 2023-08-29 03:49

Further on my plan to distribute the funds in two batches, one this year and one early next year.  Are there time limits or issues I need to heed?  Or any other issues to consider to make sure this strategy will successfully move income tax responsibility from estate to me and surviving sister?  

Submitted by Alan - IRA critic on Tue, 2023-08-29 18:57

Take a close look at the death claim form to make sure it applies to qualified plans and not to a NQ annuity. Has sister’s final 2022 return been filed, and was there any income to the estate between 11/22/2022 and 12/31/2022?

Submitted by Bruce Gordon on Wed, 2023-08-30 16:55

Alan, Sis’s account is qualified, and Plan rep confirms the Death Claim Form does apply to her account.  Sis’ 2022 personal income tax returns, state and federal, have been filed.  There may have been some estate income accrued between 11/22 and 12/31, but I don’t know how much.  CPA handling Sis’ matters says we have until one year after DOD to file first estate income tax return.  

Submitted by Alan - IRA critic on Wed, 2023-08-30 18:43

The CPA will probably use a fiscal estate tax year (11/22/2022-10/31/2023). That could work well if the first half of the balance can be distributed to the estate by 10/31, and the rest early next year. That should result in a k1 for half the balance being included in the beneficiary’s 2023 return and the other half on the 2024 return. Make sure the CPA knows when these distributions are expected after confirming with the plan when they can be made. 

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