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This month and next, I'll offer a detailed look at the issues and obligations that executors face when retirement benefits are payable to the decedent's estate. First up, required minimum distributions.
Question: I frequently find myself advising the personal representative ("executor") of an estate where the decedent either named his estate as the beneficiary of his traditional or Roth IRA or 401(k) plan, or the plan or IRA is payable to the estate because either the decedent named no beneficiary or the named beneficiary predeceased him and the estate was the default beneficiary under the plan or IRA documents.
The executor needs to know what options (and obligations) the estate has for these benefits.
- Must the estate take required minimum distributions?
- Can the estate avoid income tax on a retirement plan by passing the account or its proceeds out to the estate beneficiaries?
- What if the plan administrator mails a check to the estate without being asked?
Answer: Your last question is easy: "What if the plan administrator mails a check to the estate without being asked?" Don't negotiate that check! Send it back uncashed with a strongly worded demand that they not take any further steps until notified by the executor.
Next, here are the answers to your questions regarding minimum distributions. Since RMDs take up the entire column this month, you'll have to wait for the other answers!
In order to fulfill the estate's RMD obligations, the executor must start by determining, with respect to each plan or account payable to the estate, whether the decedent died before or after his required beginning date, or RBD. This crucial fact will tell you whether a distribution is required for the year of death, as well as what distributions must be taken in the succeeding years.
RMD for the Year of Death
If the decedent died before his RBD, there is no RMD for the year of death. If the decedent died on or after his RBD, then there is an obligation to take a distribution in the year of death. If the decedent took that RMD in full prior to his death, the estate is off the hook--it has no obligation to take any RMD that year. If the executor determines that there was an RMD for the year of death but the decedent had not fully taken it prior to death, the executor must withdraw the balance of the year-of-death RMD from the applicable plan by Dec. 31 of the year of death.
The above little dance is not as easy as it sounds. If the death occurred late in the calendar year, the executor may not have enough time before the Dec. 31 deadline to find all the necessary records, determine whether an RMD was required, and if so, to what extent the decedent satisfied the requirement during life. Fortunately, the statute provides for waiver of the 50% penalty on missed RMDs when the failure is due to "reasonable cause." This situation (decedent died late in the year, leaving the beneficiary scrambling to assemble the required information) is a prime example of reasonable cause for failing to take an RMD.
How do you know whether the decedent died before or after his RBD? It's easy to determine that in three cases, a bit harder in a fourth case. First, the three easy ones (this discussion assumes a 2021 decedent):
- If the decedent died before April 1 of the year of his 73rd birthday, he died before the RBD for all of his retirement benefits.
- With respect to any Roth IRA, he died before his RBD regardless of his age. There are no lifetime RMDs for Roth IRAs, so Roth IRAs have no RBD, and therefore death is always before the RBD with respect to a Roth IRA.
- If he died on or after April 1 of the year of his 73rd birthday, he died after his RBD for his traditional IRA.
The tricky one is the 401(k) plan, which is a "qualified retirement plan." The RBD for a qualified plan is the same as for a traditional IRA if the decedent owned more than 5% of the company that sponsors the plan--that is, April 1 of the year of the 73rd birthday. If the decedent did not own more than 5% of the employer-company, his RBD is April 1 following the year he reached age 72 or the year he retired, whichever is later. In most cases this is easy to determine because it is obvious that the decedent did or did not own more than 5% of the plan sponsor and had or had not retired. However, borderline cases can be difficult, especially since the IRS has never defined what "retired" means, and since the 5% ownership is determined as of a specific lookback date, with family and entity attribution rules applied. The executor should consult with an expert to determine the RBD for the 401(k) plan if the decedent's percentage ownership (or lack thereof) or retired status is not obvious.
And how much will that RMD be if there is one for the year of death? It will be determined using the IRS' Uniform Lifetime Table based on the age the decedent attained or would have attained on his birthday in the year of death. For example, for a 2021 decedent who attained or would have attained age 75 on his 2021 birthday, the RMD for 2021 is the account balance as of Dec. 31, 2020, divided by 22.9, the factor from this year's Uniform Lifetime Table for age 75. (As a reminder, new life expectancy tables will apply for RMD purposes starting in 2022.)
Believe it or not, this does not end the potential issues regarding the year-of-death RMD. For example, suppose the decedent had multiple traditional IRAs, only some of which were payable to the estate, and the decedent took more than he was required to take from IRAs payable to other beneficiaries. To what extent can those excess distributions from the other IRAs be deemed to satisfy the RMD obligation with respect to the IRA payable to the estate? The executor should consult a tax expert if this question arises.
RMDs for Later Years
What RMDs must the executor take for years after the year of death? The answer again depends on whether the decedent died before or after his RBD.
The decedent's estate is not and cannot be a "designated beneficiary" under IRS rules. Thus, there is no possibility of qualifying for the "life expectancy of the beneficiary" payout period available for "eligible designated beneficiaries," or even for the "10-year rule" applicable to plain-old designated beneficiaries. Under the Secure Act, as was true under pre-Secure law, the estate is not an individual and accordingly is a "nondesignated beneficiary," or NDB. As an NDB, the estate faces the following minimum distribution requirements for years after the year of death:
For any retirement plan or account as to which the decedent died before the RBD, the "five-year rule" applies. Annual distributions are not required under the five-year rule; the only requirement is that the entire account must be distributed by the end of the year that contains the fifth anniversary of the decedent's death. For our 2021 decedent, the distribution deadline under the five-year rule would be Dec. 31, 2026. Note that the distribution period actually extends over six calendar years--for example, for a death in 2021, distributions could be made at any time or times during the calendar years 2021-26. (Note also that for deaths in the years 2015-19, the five-year rule became the six-year rule in recognition of the suspension of RMDs for the year 2020.)
If the decedent died on or after his RBD with respect to any plan or account, the five-year rule does not apply to that plan or account. Instead, these benefits must be distributed in annual instalments over what would have been the decedent's single life expectancy. (As always with the minimum distribution rules, the benefits can be distributed more rapidly; the annual life expectancy payout requirement provides the minimum required distribution each year.) This payout method has been nicknamed the "ghost life expectancy" payout. Depending on the decedent's age on his year-of-death birthday, the ghost life expectancy payout period (under the IRS' new life expectancy table effective in 2022) could be anywhere from 1.0 to 15.4 years after the year of death.
In some cases the executor can have quite a tangle figuring out these RMDs for different types of plans or accounts as to some of which the decedent died before, and some after, his RBD. But that is not the executor's only or necessarily biggest problem with RMDs.
Suppose the executor has determined that the five-year rule applies to the decedent's 401(k) plan. To spread out the tax impact as much as possible, the executor asks the 401(k) plan to make annual distributions to the estate over the six calendar years 2021–26. Or if the ghost life expectancy payout applies, the executor requests annual payments over the applicable life expectancy period. The plan administrator (under almost all plans) will refuse to do any such gradual or installment payout. Most qualified retirement plans do not permit any form of distribution other than a lump sum. The executor probably will not even be permitted to leave the money in the plan for five years to obtain maximum deferral. The distribution typically must be made very shortly after the employee's death. Begging and pleading won't help: The plan administrator cannot vary these policies without amending the plan (a big deal that the employer presumably has no interest in pursuing just to keep this executor happy).
This inflexibility is in contrast to the options under an inherited IRA or Roth IRA. Most IRA providers place no restrictions on the executor's ability to take distributions from the inherited account annually, monthly, weekly, or even daily. If for some unexpected reason the IRA provider insists it will only pay the benefits in a lump sum, the executor can freely transfer the account to another IRA provider (more about this next month). In contrast, the qualified plan payable to an estate is normally a worst-case scenario under which the executor's only option is to take a 100% lump-sum distribution right now.
Needless to say, once the lump sum is distributed to the estate, the estate does not have the option to roll it over into an IRA. No beneficiary has that option except the decedent's surviving spouse. (However, if the surviving spouse is the sole beneficiary of the estate, the spouse may have the option to roll over the distribution "through" the estate; see "where to read more" below.)
To avert this unwanted lump-sum distribution, can the executor transfer the 401(k) benefits intact to an inherited IRA? Nope. The ability to transfer an inherited qualified retirement plan into an inherited IRA (via "direct rollover") is available only to designated beneficiaries. An estate is not a designated beneficiary. Vis-a-vis the administrator of a qualified plan, the decedent's executor has just about no rights. The estate is stuck with whatever option the plan offers (which is usually only a lump-sum distribution right now). This fact, even more than the less favorable minimum distribution options, is usually the main drawback of having a qualified plan payable to the estate.
Next month, I'll discuss what happens to the retirement plan distributions when they are paid to the estate, whether the executor can minimize taxes on those distributions, transferring the account or proceeds to the estate beneficiaries, and closing the estate.
Where to read more: See section 3.2.09 of the author's book Life and Death Planning for Retirement Benefits (Ataxplan Publications; 2019) for more on the spousal rollover "through" an estate or trust.
Natalie Choate is a lawyer in Wellesley, Massachusetts, who concentrates in estate planning for retirement benefits. The 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article do not necessarily reflect the views of Morningstar.