Ramifications of naming your trust as your 401k beneficiary

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pjtallman
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Ramifications of naming your trust as your 401k beneficiary

Post by pjtallman » Tue Feb 13, 2018 5:11 pm

A warning to everyone to check how you've registered your retirement account beneficiaries and make sure you understand the ramifications!

I am my mothers executor and successor trustee. She passed away on Jan 3, 2018. I am now trying to wrap up her financial affairs and found one big problem with the way she defined her beneficiary for her 401k account. Rather than name my two brothers and I as the beneficiaries directly, she listed her revokable trust as the sole beneficiary (the trust names my brothers and I the beneficiaries). I know there are reasons to do this, but in our situation there was no reason to do this.

The impact of this was immediately apparent when I tried to rollover the 401k to three Inherited IRAs and was told I could not. First the 401k had to be re-registered to the trust (that has been done), next I need to first rollover the 401k to an Inherited IRA in the name of the trust and only then can I change ownership to my brothers and I resulting in us each having an Inherited IRA as a result fo this 401k. What a mess, but that isn't all. I called today to do the rollover from the 401k to the trust's Inherited IRA. But I was stopped in my tracks when I was told I'd have to first take the 401k's RMD for 2018 which, of course, will cause a taxable event for the trust. And the tax rates for trusts are far more, I am told, than for individuals not to mention I was not intending to have the trust report any income for 2018 (all income was to be distributed...maybe the RMD distribution can be distributed to my brothers and I and we pay the tax via K-1???).

My question is if this is correct? I had thought (1) there was a "gap" year between when RMD's had to be taken by Inherited IRAs and (2) my brothers and I would take the distribution once the money had been moved to three Inherited IRAs. I ask only because I am finding I get different answers from the 401k manager depending on who I talk to.

--Pat

123
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Re: Ramifications of naming your trust as your 401k beneficiary

Post by 123 » Tue Feb 13, 2018 5:16 pm

The required RMD for 2018 is the one for the account owner (deceased). That's the way it works.

Edited to add:
Vanguard says:

"If you inherit the IRA, you must begin taking RMDs by December 31 of the year after the year of the IRA owner's death, based on the longer of:

Your life expectancy expectancy, or
The IRA owner's remaining life expectancy.

You must take an RMD for the year of the IRA owner's death if the owner hasn't already taken one for that year."
The closest helping hand is at the end of your own arm.

Alan S.
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Re: Ramifications of naming your trust as your 401k beneficiary

Post by Alan S. » Tue Feb 13, 2018 5:57 pm

Sorry for your loss. The last post is correct regarding the year of death RMD.

For all direct rollovers of qualified plans, RMDs due up to and including the year of the rollover must be distributed before a direct rollover to an IRA is allowed. This of course assumes that 2018 would have been an RMD distribution year for your mother. That generally means that she was no longer working for the plan sponsor at the time of her death.

There is another hurdle that you did not mention, but it appears it has cleared. For a direct rollover to an inherited IRA to be done at all, the trust must be qualified for look through treatment. That allows the RMDs to the trust to be based on the oldest beneficiary of the trust, but in this case it also is a requirement to even get the account to an inherited IRA. One of the requirements is that key data for the trust must be submitted to the plan, but if the plan has agreed to do the direct rollover, this must have been completed already. It probably also means that there are no non individual beneficiaries of the trust such as a charity.

As for the plan year of death RMD distributed to the trust and reported on a 1099R, this distribution can be passed through the trust per Form K 1 to each trust beneficiary and then will be reportable and taxed on each beneficiary's 1040, rather than being subject to the high trust tax rates. It means you will have to file a 1041 do to this. It also goes without saying that the trust provisions ALLOW the trust to be terminated or allow you the discretion to terminate it. Ironically, if it does allow for termination there probably was no point in naming the trust as the plan beneficiary in the first place.

The gap year you refer to is for your own beneficiary RMDs which are due by 12/31/2019 at the latest. Well prior to that date, you should have been able to assign the now inherited IRA to each trust beneficiary, so each such beneficiary will be able to manage their own inherited IRA, name their own successor beneficiaries etc. However, because the actual beneficiary was still a qualified trust, each inherited IRA beneficiary will still have to use the RMD divisor of the oldest. The younger beneficiaries will then have to receive RMDs that are larger than if they inherited directly from the 401k.

Some IRA custodians balk at the assignment out of trust transaction, so I suggest that each of you select one of the top national firms as your inherited IRA custodians. If you use a small local bank or similar, you are likely to have problems with the assignment process.

You are absolutely correct with your concern about the trust as beneficiary. That's fine if there is a good reason for it, but otherwise results in problems. However, a qualified trust is still better than a NQ trust or an estate as beneficiary. In those cases, the IRA rollover could not even be done and in addition the plan would probably push out a lump sum distribution, all immediately taxable.

pjtallman
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Joined: Fri Jun 13, 2008 12:01 pm

Re: Ramifications of naming your trust as your 401k beneficiary

Post by pjtallman » Tue Feb 13, 2018 6:24 pm

Thank you all for your responses, it confirms what I was told by 401k managers.

For completeness the answers to Alan S. in case it helps someone in the future...

1. Yes, my mother was already taking RMDs for many years now, so I will have to take the 2018 RMD
2. Trust is qualified for look through treatment and my brothers and I are only beneficiaries

Special thanks for the info on the 1099R and passing the distribution through using K-1 to beneficiaries and filing 1041 for trust. I was already going to have to file anyway to report the income being generated by some non-retirement bond funds prior to distribution to my brothers and I. I am glad this will work for the RMD distribution as well. And I was aware that due to the trust being beneficiary, all beneficiaries will have to use my older brothers DOB for RMD calculations.

--Pat

bsteiner
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Re: Ramifications of naming your trust as your 401k beneficiary

Post by bsteiner » Tue Feb 13, 2018 9:13 pm

It would have been better if she had named her children or trusts for her children as the beneficiaries.

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Earl Lemongrab
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Re: Ramifications of naming your trust as your 401k beneficiary

Post by Earl Lemongrab » Wed Feb 14, 2018 2:21 pm

Are you sure that the trust will have to pay taxes on the RMD versus being spun out to the beneficiaries with K-1 forms?
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Alan S.
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Re: Ramifications of naming your trust as your 401k beneficiary

Post by Alan S. » Wed Feb 14, 2018 2:31 pm

Earl Lemongrab wrote:
Wed Feb 14, 2018 2:21 pm
Are you sure that the trust will have to pay taxes on the RMD versus being spun out to the beneficiaries with K-1 forms?
No, the K-1 will transfer tax to the beneficiary 1040s. The trust would only pay the higher rates if the RMDs were accumulated in the trust or allowed the trustee discretion to do that.

matt fe2o3
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Re: Ramifications of naming your trust as your 401k beneficiary

Post by matt fe2o3 » Thu Feb 15, 2018 4:10 am

I hate to say it but we have neglected to update our living trust for some time.

OP thanks for the post - it's a kick in the rear to update and more importantly research.

Ughhh...

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