Your 401k, u die, must beneficiary withdraw within 5 years?

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livesoft
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Your 401k, u die, must beneficiary withdraw within 5 years?

Post by livesoft »

OK, I came across a possible problem with some 401(k) plans this week. Apparently, some plans require the beneficiaries to withdraw all the assets within 5 years after the date of death of the owner. It also seems like sometimes the beneficiaries may not be able to rollover an inherited 401(k) to an inherited IRA. Or maybe this was some old rule that no longer applies. Now I am not concerned about 401(k)s with low asset values of $5,000 or below. I am talking about a 401(k) with substantial value.

Can folks comment on this for me please? In particular I have 2 questions:

1. Does your 401(k) plan require complete withdrawal by the beneficiaries within a set time period (say 5 years) after you die?

2. Are their any plans where the beneficiaries cannot roll over an inherited 401(k) into an inherited IRA?

Thanks for all comments.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by placeholder »

According to brief research as of the 2006 Pension Protection Act any beneficiaries can roll over to an IRA.
sscritic
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by sscritic »

I think placeholder has it. From 2006, showing the old and the new:
In the past, though, inheriting a 401(k) from someone who wasn't your spouse was a lesson in diminishing returns. By law, "non-spouses" couldn't roll over an inherited 401(k) into their own IRAs.

Most company 401(k) plans require beneficiaries to withdraw all the money in a lump sum, usually within one to five years after the plan owner dies. Unable to roll the money into an IRA, heirs had no choice but to pay federal and state taxes on the entire balance, says Natalie Choate, an attorney and author of Life and Death Planning for Retirement Benefits. By then, the inheritance had often shrunk by a third or more.

Fortunately, the pension-reform law signed by President Bush last month included a provision that will make a 401(k) a much nicer asset to inherit — for everyone.

Starting in 2007, children, unmarried partners and other non-spouses will be allowed to transfer an inherited 401(k) to an individual retirement account. They'll be required to take annual withdrawals, but that amount will be based on their life expectancy.
I actually think this is not quite right. It used to depend on whether the RMDs had started for the deceased.
sscritic
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by sscritic »

There is a 5 year rule for an IRA if the beneficiary is not an individual (you didn't specify) and the death is before the RBD.
If the owner died before his or her required beginning date (defined earlier) ... If the owner's beneficiary is not an individual (for example, if the beneficiary is the owner's estate), the 5-year rule (discussed later) applies.
...
The 5-year rule requires the IRA beneficiaries to withdraw 100% of the IRA by December 31 of the year containing the fifth anniversary of the owner’s death.
26 USC 401(a)(9) contains similar language:
(A) In general.— A trust shall not constitute a qualified trust under this subsection unless the plan provides that the entire interest of each employee—
  • (i) will be distributed to such employee not later than the required beginning date, or
    (ii) will be distributed, beginning not later than the required beginning date, in accordance with regulations, over the life of such employee or over the lives of such employee and a designated beneficiary (or over a period not extending beyond the life expectancy of such employee or the life expectancy of such employee and a designated beneficiary).
(B) Required distribution where employee dies before entire interest is distributed.—
  • (i) Where distributions have begun under subparagraph (A)(ii).—A trust shall not constitute a qualified trust under this section unless the plan provides that if—
    • (I) the distribution of the employee’s interest has begun in accordance with subparagraph (A)(ii), and
      (II) the employee dies before his entire interest has been distributed to him,
      the remaining portion of such interest will be distributed at least as rapidly as under the method of distributions being used under subparagraph (A)(ii) as of the date of his death.
    (ii) 5-year rule for other cases.— A trust shall not constitute a qualified trust under this section unless the plan provides that, if an employee dies before the distribution of the employee’s interest has begun in accordance with subparagraph (A)(ii), the entire interest of the employee will be distributed within 5 years after the death of such employee.
That section is then followed by exceptions for payments over a lifetime and for spouses.

Actually, those are the rules for an IRA. An IRA doesn't have its own rules.

26 USC 408 (a)(6)
Under regulations prescribed by the Secretary, rules similar to the rules of section 401 (a)(9) and the incidental death benefit requirements of section 401 (a) shall apply to the distribution of the entire interest of an individual for whose benefit the trust is maintained.
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livesoft
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by livesoft »

Thanks to both for the responses. I was in the library reading an old book, so my info was stale, but I was not re-assured by talking to my plan provider.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by LadyGeek »

This thread is now in the Personal Finance (Not Investing) forum (401(k) plan rules).
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mah001
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by mah001 »

Try pub 6392, item II. e. for the rollover part.
Try pub 7004, item II b. for the rmd part.
There are cites, e.g. code and regs.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by sscritic »

mah001 wrote:Try pub 6392, item II. e. for the rollover part.
Try pub 7004, item II b. for the rmd part.
There are cites, e.g. code and regs.
Gotta go to Broncos' practice.
Thanks, but I am still confused:
For this purpose, a distributee includes only the employee and the employee’s surviving spouse (or the employee’s spouse or former spouse, if designated as an alternate payee under a qualified domestic relations order).
pub 6392

This doesn't cover the non-spouse beneficiary.

This is clear:
If a plan does not adopt an optional provision specifying the method of distribution after the death of the participant or allow participants or beneficiaries to elect on an individual basis whether the 5-year rule or the life expectancy rule applies, the default rule when the participant has a designated beneficiary is the life expectancy rule. A plan may adopt a provision that permits employees (or beneficiaries) to elect, in accordance with section 1.401(a)(9)-3 of the regulations, on an individual basis whether the five-year rule or the life expectancy rule applies to distributions after the death of an employee who has a designated beneficiary.
pub 7004

The plan has options, so not all plans are alike in this regard. However, life expectancy is always a choice; the option is on the 5-year rule as I read things.

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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by Alan S. »

I don't see where the most critical point here has been posted. According to the special rule in Q&A 17 of Notice 2007-7, the direct rollover to an inherited IRA of the non spouse beneficiary must be completed no later than 12/31 of the year following the year of employee's death:
(2) Special rule. If, under paragraph (b) or (c) of Q&A-4 of § 1.401(a)(9)-3, the
5-year rule applies, the nonspouse designated beneficiary may determine the required
minimum distribution under the plan using the life expectancy rule in the case of a
distribution made prior to the end of the year following the year of death. However, in
order to use this rule, the required minimum distributions under the IRA to which the
direct rollover is made must be determined under the life expectancy rule using the
same designated beneficiary.
Therefore, when the QRP contains a mandatory 5 year rule, the direct rollover must meet the above deadline to restore a life expectancy stretch. If it does not, the inherited IRA is bound by the QRP RMD provisions and beneficiary is stuck with the 5 year rule. Note that the special rule ONLY applies to designated beneficiaries, NOT to beneficiaries of an estate beneficiary should the estate be the QRP beneficiary. Of course, the 5 year rule itself can only apply to deaths PRIOR to the RBD.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by mah001 »

Plan must meet 401(a)(9) ---provide plan provision and then follow it. If plan's method is faster than it needed to be and beneficiary is taxed sooner than would have been possible, the plan is under no obligation to act differently. But if plan's distribution options include dollars that are not rmds and can be rolled, then 402(c)(11) requires nonspousal beneficiary to receive same rollover rights as employee and spouse.

This is effective for plan years that begin in 2010. Maybe it wasn't in the Explanation #4 because it didn't make the cut/is too recent. the alert guidelines tend to run a few years behind. they might now be linked to the current cycle of determination letter applications being worked in Cincinnati.
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livesoft
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by livesoft »

Alright, so the bottom line is that there are probably some 401(k) plans that have not been updated and probably still have a 5-year rule for non-spouse beneficiaries? Is that a likely to be correct statement?
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mah001
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by mah001 »

Looks like we're saying the 5 year rule does allow for rolling/stretching if distributee timely acts.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by mah001 »

As for the plan provision, I don't have top of head knowledge of its required adoption deadline; there might not be an amendment required for this unless it's actually possible in the plan. Effective in the plan's operation for plan years beginning in 2010.
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livesoft
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by livesoft »

Since inherited IRAs also have a 5-year rule (if RMDs are not started in time, then no stretching and all assets should be withdrawn in 5-years), it appears that there is really no difference anymore between a 401(k) and an IRA with respect to non-spouse beneficiary … as long as beneficiary rolls over the inherited 401(K) to an inherited IRA in a timely manner.

I called my 401(k) help center and the rep said something like, "I don't see a mention of '5-years' anywhere, but I have seen that with some other 401(k)s."

I suppose it is probably too much to ask our readers if their 401(k) has an embedded mention of the 5-year rule.
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Alan S.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by Alan S. »

This is a copy of Q&A 4 of IRS Reg 1.401(a)(9)-3 describing some common plan options for RMDs for deaths prior to the RBD:
Q-4. How is it determined whether the 5-year rule in section 401(a)(9)(B)(ii) or the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) applies to a distribution?

A-4. (a) No plan provision. If a plan does not adopt an optional provision described in paragraph (b) or (c) of this A-4 specifying the method of distribution after the death of an employee, distribution must be made as follows:

(1) If the employee has a designated beneficiary, as determined under § 1.401(a)(9)-4, distributions are to be made in accordance with the life expectancy rule in section 401(a)(9)(B)(iii) and (iv).

(2) If the employee has no designated beneficiary, distributions are to be made in accordance with the 5-year rule in section 401(a)(9)(B)(ii).

(b) Optional plan provisions. A plan may adopt a provision specifying either that the 5-year rule in section 401(a)(9)(B)(ii) will apply to certain distributions after the death of an employee even if the employee has a designated beneficiary or that distribution in every case will be made in accordance with the 5-year rule in section 401(a)(9)(B)(ii). Further, a plan need not have the same method of distribution for the benefits of all employees in order to satisfy section 401(a)(9).

(c) Elections. A plan may adopt a provision that permits employees (or beneficiaries) to elect on an individual basis whether the 5-year rule in section 401(a)(9)(B)(ii) or the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) applies to distributions after the death of an employee who has a designated beneficiary. Such an election must be made no later than the earlier of the end of the calendar year in which distribution would be required to commence in order to satisfy the requirements for the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) (see A-3 of this section for the determination of such calendar year) or the end of the calendar year which contains the fifth anniversary of the date of death of the employee. As of the last date the election may be made, the election must be irrevocable with respect to the beneficiary (and all subsequent beneficiaries) and must apply to all subsequent calendar years. If a plan provides for the election, the plan may also specify the method of distribution that applies if neither the employee nor the beneficiary makes the election. If neither the employee nor the beneficiary elects a method and the plan does not specify which method applies, distribution must be made in accordance with paragraph (a) of this A-4.
I don't have an estimate of how common each of these options apply in current plan docs. But a plan MUST offer the non spouse beneficiary a transfer to an inherited IRA if requested (effective with plan years starting in 2010). This should obviously be done by the aforementioned deadline.
Non-spouse beneficiary direct rollovers
PPA allows non-spouse beneficiaries to make a direct rollover of a death benefit payment from a qualified defined benefit or defined contribution plan, section 403(b) plan, or governmental section 457(b) plan to an IRA. These direct rollovers are available for distributions made after December 31, 2006.
IRS Notice 2007-7 provided guidance that plans were permitted, but not required, to offer these direct rollovers to non-spouse beneficiaries. However, the technical corrections in WRERA clarify that, effective for plan years beginning after December 31, 2009, plans are required to provide a direct rollover option for non-spouse beneficiaries and must provide a 402(f) notice.
Last edited by Alan S. on Thu Jul 31, 2014 7:11 pm, edited 1 time in total.
Topic Author
livesoft
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by livesoft »

OK, suppose that a non-spouse beneficiary of a 401(k) does nothing for 4 years after inheriting the 401(k). Then they wake up and think, "OMG, if I don't rollover to an inherited IRA, I will have to withdraw the whole kit-and-kaboodle next year and pay a lot of tax." So they rollover to an inherited IRA. Are they then able to stretch that IRA with annual RMDs? Does a new 5-years start over for the inherited IRA?

(I know it was probably in the regs quoted already in this thread, but after a couple of margaritas, I am having a bit of trouble with comprehension, but no trouble coming up with wild ideas.)
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Alan S.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by Alan S. »

livesoft wrote:OK, suppose that a non-spouse beneficiary of a 401(k) does nothing for 4 years after inheriting the 401(k). Then they wake up and think, "OMG, if I don't rollover to an inherited IRA, I will have to withdraw the whole kit-and-kaboodle next year and pay a lot of tax." So they rollover to an inherited IRA. Are they then able to stretch that IRA with annual RMDs? Does a new 5-years start over for the inherited IRA?

(I know it was probably in the regs quoted already in this thread, but after a couple of margaritas, I am having a bit of trouble with comprehension, but no trouble coming up with wild ideas.)
As stated in an earlier post, if the non spouse beneficiary does not complete the direct rollover by 12/31 of the year following the year of employee's death, the beneficiary is STUCK with the plan provisions. While the funds are in an inherited IRA, they must be treated for RMD purposes as if they were still in the plan.

Don't ask me how the IRA custodian is going to collect and enforce the distributing plan RMD provision that applied to that plan, or if any of them make an effort. Now if the beneficiary inherited an IRA rather than a QRP (very few IRAs still have a mandatory 5 year rule), they could restore the life expectancy stretch per PLR 2008 11028 by making up the missed life expectancy RMDs and paying the 50% penalty for the delinquent ones. Further, there is nothing to lose by pushing this a step further and requesting a waiver of the penalty on Form 5329. The IRS waives many of these excess accumulation penalties when the taxpayer makes up the late RMDs and self reports using the "reasonable cause" procedure in the 5329 Inst. And if the beneficiary is young enough the penalty may be affordable.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by livesoft »

Muchas gracias!
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by sscritic »

Alan: one follow up.

Earlier, you quoted the following:
A plan may adopt a provision that permits employees (or beneficiaries) to elect on an individual basis whether the 5-year rule in section 401(a)(9)(B)(ii) or the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) applies to distributions after the death of an employee who has a designated beneficiary. Such an election must be made no later than the earlier of the end of the calendar year in which distribution would be required to commence in order to satisfy the requirements for the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) ... or the end of the calendar year which contains the fifth anniversary of the date of death of the employee.
Since 401(a)(9)(B)(iv) is "Special rule for surviving spouse of employee," I looked to (iii) for the non-spouse beneficiary (livesoft's question).
(iii) Exception to 5-year rule for certain amounts payable over life of beneficiary.— If—
(I) any portion of the employee’s interest is payable to (or for the benefit of) a designated beneficiary,
(II) such portion will be distributed (in accordance with regulations) over the life of such designated beneficiary (or over a period not extending beyond the life expectancy of such beneficiary), and
(III) such distributions begin not later than 1 year after the date of the employee’s death or such later date as the Secretary may by regulations prescribe,
for purposes of clause (ii), the portion referred to in subclause (I) shall be treated as distributed on the date on which such distributions begin.
This is the one-year rule for commencement, but what you quoted gives you until the end of the year after the first anniversary (or is this the work of the Secretary?).
Q-3. When are distributions required to commence in order to satisfy the life expectancy rule in section 401(a)(9)(B)(iii) and (iv)?

A-3. (a) Nonspouse beneficiary. In order to satisfy the life expectancy rule in section 401(a)(9)(B)(iii), if the designated beneficiary is not the employee's surviving spouse, distributions must commence on or before the end of the calendar year immediately following the calendar year in which the employee died.
Which leads me to my real question: when would the end of the calendar year which contains the fifth anniversary of the date of death of the employee be earlier than the end of the calendar year in which distribution would be required to commence in order to satisfy the requirements for the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) [the first quote above from your post]? I am having trouble imagining the circumstances. Maybe I need one of livesoft's margaritas. :)

Edit: I think I have it: a surviving spouse has until the date on which the employee would have attained age 70 1/2, which could be later than the year in which the five year death anniversary occurs.
Alan S.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by Alan S. »

Yup, you came up with the answer. Spouses have quite a number of RMD related preferences, but to use the decedent's age 70.5 year the spouse must be the sole beneficiary. So a 401k set up with a spouse and another beneficiary listed would accelerate the decision date for the spouse.

But the separate account rules apply to a QRP just as they do for an IRA. With an IRA of course there must be a separate account number and account created, but with a QRP the same can be done with internal accounting within the plan. So if there is a spousal and non spousal beneficiary named, separate accounts can be created in the plan under which the spouse can actually be deemed a sole beneficiary and delay RMD until the decedent would have reached 70.5. The deadline for those separate accounts is the same date as used to get the non spouse beneficiary out of a mandatory plan 5 year rule by doing the direct rollover to an inherited IRA. The spousal beneficiary would then have more time to do that direct rollover or even an indirect rollover to their own IRA.
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Re: Your 401k, u die, must beneficiary withdraw within 5 yea

Post by fcirullo »

Great question! I have included this thread in the wiki article setting up a 401(k) plan.
Wiki article link: Setting up a 401(k) plan

You can find the link under Frequently asked questions.
Frank R. Cirullo | | "It isn't what we don't know that gives us trouble, it's what we know that ain't so." -- | Will Rogers
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