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Death Distinctions Between 401(k)s and IRAs

Contributor Natalie Choate discusses the challenges--and limitations--for heirs when beneficiary designations aren't completed for retirement accounts.

If you're going to die without an estate plan, it's probably better for your heirs if your retirement money is in an IRA rather than a qualified retirement plan.

Frank and Bill, both unmarried, both die in 2019 at age 65. Each of them has $500,000 in a retirement plan account. Each has a simple will leaving his estate to his three adult children but never bothered to complete a beneficiary designation form for his retirement plan. Frank's retirement account is a 401(k) plan; Bill's is an IRA.

When a retirement plan participant dies without an effective beneficiary designation, we have to review the terms of the retirement plan or the IRA agreement. This plan document will specify what happens to the benefits of a deceased employee or IRA owner when there is no beneficiary designation in place: The plan specifies a default beneficiary.

Because Frank's plan is a qualified retirement plan, ERISA generally specifies the default beneficiary for all or much of the account: the employee's surviving spouse. Since Frank was unmarried, however, ERISA no longer mandates who the default beneficiary is and the plan can provide whatever it wants. Most plans specify that the death benefits of an unmarried employee who dies without having designated a beneficiary will be paid to the employee's estate--and that's what Frank's 401(k) plan provides. 

Bill's IRA is not subject to ERISA, so there is no federally mandated benefit payable to the surviving spouse. Some IRAs, like some qualified plans, will specify individual default beneficiaries, such as the decedent's surviving spouse or issue. However, most IRAs, like most qualified plans, provide that the benefits not disposed of by the employee's beneficiary designation will be paid to the employee's estate--and that's what Bill's IRA provides.

When your beneficiary is your estate, IRS regulations tell us you do not have a designated beneficiary according to their definition. "Designated beneficiary" is a defined term in the minimum distribution rules--it means an individual (human being, or a group of individuals) or a qualifying see-through trust that has met the IRS requirements for a trust to qualify for designated beneficiary status. A designated beneficiary gets big advantages under the tax law, the main one being the option to defer distribution of the inherited retirement benefits and withdraw them gradually over the designated beneficiary's life expectancy.

But an estate? An estate (or a trust that does not meet the see-through trust requirements) is not and cannot be a designated beneficiary. Thus an estate cannot be entitled to the life expectancy of the beneficiary payout period for the inherited benefits. Instead, under the minimum distribution rules, an estate is stuck with the much more limited no-designated-beneficiary payout option, which is:

--If the decedent died before he/she was required to start taking minimum distributions, all benefits must be distributed by the end of the year that contains the fifth anniversary of the date of death (the five-year rule); or

--If the decedent died on or after his required beginning date for minimum distributions, all benefits must be distributed in annual installments over what would have been the decedent's life expectancy had he not died.

Since Bill and Frank both died before attaining age 70½--and therefore before their respective required beginning dates--and since neither had a designated beneficiary, both estates are subject to the five-year rule. The minimum distribution rules dictate that for both men, all their benefits must be distributed out of the retirement accounts no later than Dec. 31, 2024.

The children as beneficiaries don't get a life expectancy payout, which would have been nice for them--even though they are the sole beneficiaries inheriting these benefits. Because they inherited the benefits through an estate instead of directly, the IRS' hard and fast rule is: no life-expectancy-of-the-beneficiary payout is allowed, period.

But at least they get something, right? By taking advantage of the five-year rule, they can spread the payout over six taxable years, 2019–24, right?

Yes and no.

For Bill's heirs, the answer is yes: The executor controls the inherited IRA, which is now registered in the name of "Bill's estate, as beneficiary of Bill." All the tax law requires is that the estate withdraw the entire IRA no later than Dec, 31, 2024. The executor can withdraw as much or as little from the IRA as the executor chooses, as long as 100% is out by Dec, 31, 2024. The executor agrees with the children: The IRA will be drawn down at approximately the rate one sixth in 2019, one fifth in 2020, one fourth in 2021, and so on until 100% is withdrawn in the final year. Each year's IRA distribution to the estate will be passed out to the children equally as distributable net income (after payment of the estate's expenses), for inclusion in each child's gross income.

Better yet, the executor, after wrapping up all the matters involved in Bill's estate, can transfer the IRA, in three pieces, out to inherited IRAs in the names of the respective children, as successor beneficiaries of Bill. That way the estate can be closed, and each child can control his or her own investments and rate of withdrawals. Some IRA providers do not permit such transfers, but many do, and if Bill's particular IRA provider balks at allowing this transfer, the executor can simply transfer the IRA (still in the name of the estate) to a different IRA provider.

As a reminder, transferring the IRA from the estate to its beneficiaries does not revive or create the option of a life expectancy payout. The transferees simply continue whatever payout period applied to the estate.

Frank's heirs are not so lucky. Frank's executor tells the 401(k) plan, "We would like to withdraw the 401(k) account in six installments over the years 2019-24." The plan administrator says, "The only form of benefit under this plan is a lump sum distribution. We do not offer installment payouts of any type." The executor says, "Can we defer that lump sum payout until 2024?" And the plan administrator says, "No, we are going to give you a check for $500,000 payable to the estate, immediately." The executor says, "Can you buy a five-year annuity and then transfer the contract to us?" The plan administrator says, "To do that, we would have to amend the plan, hire a lawyer, file with the IRS for approval, and offer that option to everyone. So, no." The executor says, "Can you transfer the lump sum to an inherited IRA where we can have more control over the payout period?" And the plan administrator says, "No. Here's your check. Goodbye."

The plan administrator is right. The plan is not required to offer any type of installment or deferred payout, and it is not permitted to transfer that inherited 401(k) account into an inherited IRA. If a 401(k) account is payable to a designated beneficiary, the plan is required to transfer the benefits to an inherited IRA if the beneficiary so requests--but (at the risk of repeating), Frank didn't name a designated beneficiary, the default beneficiary under this plan is the estate and an estate is not a designated beneficiary.

Clearly the best thing for Frank and Bill to have done would be to have filed beneficiary designation forms, naming their children as their designated beneficiaries. They failed to do so. But by the luck of the draw, Bill's children can salvage some deferral out of the situation since Bill's benefits were in an IRA, while Frank's children are stuck with an immediately payable, immediately taxable lump sum because his benefits were in a 401(k).

Where to read more: For explanation of the minimum distribution rules generally, including definition of designated beneficiary and required beginning date, see Chapter 1 of the author's book Life and Death Planning for Retirement Benefits (8th ed. 2019); for the minimum distribution trust rules see Chapter 6; for ability of beneficiaries to transfer inherited benefits (or not), see Chapter 4.

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website,, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.