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Estate Administration of Retirement Accounts: An Overview

Scott Grossman

Scott Grossman

Attorney

The Grossman Law Firm, APC · 525 B Street, Suite 1500, San Diego, CA 92101 · (951) 523-8307

About Estate Administration of Retirement Accounts:

When your loved one passes away, many assets will need to be managed and distributed to beneficiaries. It is important for the person in charge of administering the estate to understand the differing rules and procedures that apply to different types of assets. Depending on whether there was a will or a trust, some assets may also be subject to probate administration proceedings. Retirement accounts are one common type of asset that can present unique challenges for the person in charge of administering the estate, though they are typically not subject to probate.

IRAs vs. 401(k)s and Beneficiary Designations

Retirement accounts typically avoid probate because they allow for a beneficiary to be named by the person who owns the account, also sometimes referred to as the plan participant. If a beneficiary is named, the asset automatically passes to the beneficiary upon the death of the owner or plan participant without requiring oversight of the probate court. The following is a helpful overview of the rules relating to IRAs and 401(k)s and beneficiary designations:

  1. An IRA or a Roth IRA can have a trust as a beneficiary and may be designed so that the payouts are over a person’s life expectancy.
  2. This is a big advantage, because it means that payouts can be stretched out over the life expectancy of a beneficiary of the trust. To qualify, the trust must be a revocable living trust and must have “look-through” provisions.
  3. Some 401(k) or a 403(b) plans, however, do not allow for payouts to a trust made over a person’s life expectancy.
  4. If a 401(k) or a 403(b) has a trust named as the beneficiary and does not allow for payouts to a trust made over a person’s life expectancy, the trust must receive the entire plan account balance shortly after the owner’s death. This may result in substantial income tax consequences at that time.

When it comes time to administer an estate after someone dies, the estate administrator must pay close attention to the minimum required distribution rules with regard to retirement assets.

How Minimum Required Distributions Impact Estate Administration:

A minimum required distribution is the minimum amount of money that must be withdrawn from a retirement asset account after the required beginning date. The required beginning date is the date at which a plan participant and IRS holder must begin taking minimum withdrawals from their retirement asset accounts. Minimum required distributions are calculated by using a Single Life Expectancy Table to obtain a life expectancy factor. This factor is then multiplied by the fair market value of the account. The resulting dollar amount is the minimum required distribution for the year. If this amount is not taken out, a penalty as high as 50% is imposed by the IRS.

When a plan participant or IRA owner dies before the required beginning date, it is important for estate administrators to understand what happens next. The law requires that a full distribution of the account must occur by December 31st of the fifth year following the death. Unfortunately, this can result in a large income tax for the beneficiary. If a plan participant or IRS owner dies after minimum required distributions have begun, the distributions must continue over the participant’s life expectancy had he continued to live.

Special Rules When Dealing with Estate Administration of Retirement Accounts:

If your loved one had an estate plan in place before passing, he may have taken steps to prevent some of the income tax consequences outlined above with regard to his retirement assets. These are some special rules when your loved one factored his retirement accounts into his estate plan. Some examples include the following:

  1. He may have named a trust as a “designated” beneficiary. A designated beneficiary is defined by the IRS as a living, breathing person whose life expectancy will be used to calculate minimum required distributions from the account each year. When the designated beneficiary is a trust, the person with the shortest life expectancy among the named beneficiaries of the trust is used to calculate the withdrawal amounts. It is important to note, however, that the trust will not qualify as a designated beneficiary if a charity, estate, or other entity that does not have a life expectancy is named as one of the beneficiaries of the trust.
  2. He may have included “look-through” provisions in his trust. A trust can only be treated as a designated beneficiary if it contains look-through provisions. To qualify, the trust must be valid under state law, must be irrevocable or become irrevocable upon the death of the plan participant, the beneficiaries of the trust must be identifiable, and the plan administrator must be given a copy of the trust on or before the date when distributions are required from the plan.
  3. He may have rolled over the account into an IRA. As noted above, some types of plans, such as 401(k)s or 403(b)s, do not allow for a trust to be named as a beneficiary. If your loved one was retired at the time he passed away, he may have rolled over his account into an IRA that allows for a trust with look-through provisions to be named as a beneficiary.
  4. The surviving spouse may roll over the inheritance into an IRA. It is important to note that if your loved one had a spouse, the spouse may be able to roll over the plan into an inherited IRA if he or she is too young to draw on the account without incurring tax penalties. If the surviving spouse is 59 ½ or older, he or she can roll over the plan into his or her own IRA.

Clearly, the rules surrounding retirement assets are complex. Fortunately, we are here to help guide you. We encourage you to contact us today at (888) 443-6590 for a free consultation.

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