Beneficiary of Father who passed away while contributed to 401k was still working - RMD required?

[taxproDE]

Hello Community, 

Hoping you all can provide insight and verify my suspicions on this one. 

My client, age 57, inherited 1/3 of his father's 401k. Some background on my client's father, he was age 83 at the time of his death; however, he was still working and contributing to the 401k plan. Therefore, his father, even though he was past the required beginning date, was not taking RMDs because he was still working at the time of his death

My client was a designated beneficiary of the 401k by his father at the time of his passing, and has since taken the 401k and rolled it over to an inherited IRA. 

My understanding, from Fidelity, is the following: 

10-year rule for inherited IRAs

If the original owner of your inherited assets passed away before they began taking required minimum distributions, you can elect to transfer inherited assets to an inherited IRA in your name and fully withdraw the account down to zero by the end of the year including the 10th anniversary of their passing. This option allows you to decide how much and how often you withdraw from the account over the course of the 10-year period. As long as the inherited IRA has been fully depleted by the end of the applicable 10-year period, withdrawals (or lack thereof) during that time are up to you.

https://www.fidelity.com/learning-center/personal-finance/retirement/non-spouse-IRA

With that being said - I think my client does not need to take an RMD from his inherited IRA, and can elect the 10 year rule, is my understanding correct? 

[qbteachmt]

Yes.

The options would be lump sum or transfer as inherited IRA.

Death does not override the "still working" provision. The RBD was never reached. Your client can take nothing in years 1-9, for example.

[Jim-from-Ohio]

@qbteachmt off the original question but QB, the 10 year rule. I had an investement advisor tell me the ten year rule does not mean years 1-9 can be zero but something every year has to be taken out.  Is it your understanding years  1 - 9  can be skipped?  I looked it up and found conflicting info

[Taxes-by-Rocky]

What was the date of death?  Before or after Secure 2.0?

[qbteachmt]

@Jim-from-Ohio 

Yes, it's all been a moving target. There are some proposed rules that were expected to have been put in place in 2024, but I haven't seen anything new released and it's likely too late this year for anything to be issued now. Of course, it could be issued retroactively but also waived for 2020-2024. They're done that in the past with the RMD penalties while trying to decide which mechanism accomplishes the new rules (IRS Notice 2024-35). This is why you'll see the media start to issue articles about, "New Rules in 2025 for Inherited IRA Accounts" but they are not new rules. They are an expiration of the transition relief.

I'm pretty sure the provision this scenario falls under hasn't changed between the SECURE Acts. Here's how it currently stands, as I've been following it. We're going to assume everything up to this point has been done properly (didn't own over 5% of the company) and that this was a recent death, so it falls under SECURE Act 2.0, where there is any difference.

This non-spouse and noneligible designated individual beneficiary inherited from the parent. The account holder for this account never reached their RBD (required beginning date), so no RMD requirement exists. Death doesn't substitute for retirement. That's what makes this unusual despite the decedent's age.

If you search, you'll see wording such as:

"and on or after the employee’s (or IRA owner’s) required beginning date"

And for reference:

https://www.journalofaccountancy.com/issues/2023/apr/beneficiary-iras-a-guide-to-the-rmd-maze.html

Also, IRS Pub 590-B:

Payment under the 10-year rule.

If the IRA owner dies before the required beginning date and the 10-year rule applies, no distribution is required for any year before the 10th year.

[Jim-from-Ohio]

thanks qb

[BobKamman]

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@qbteachmt wrote:

@Jim-from-Ohio 

Yes, it's all been a moving target. There are some proposed rules that were expected to have been put in place in 2024, but I haven't seen anything new released and it's likely too late this year for anything to be issued now.  

I thought this was done in July.  But I was on vacation and I'm not responsible for anything IRS does while I'm gone.

IR-2024-190, July 18, 2024

WASHINGTON — The Department of the Treasury and the Internal Revenue Service today issued final regulations updating the required minimum distribution (RMD) rules.

The final regulations reflect changes made by the SECURE Act and the SECURE 2.0 Act impacting retirement plan participants, IRA owners and their beneficiaries. At the same time, Treasury and IRS issued proposed regulations, addressing additional RMD issues under the SECURE 2.0 Act.

While certain changes were made in response to comments received on the proposed regulations issued in 2022, the final regulations generally follow those proposed regulations.

Specifically, Treasury and IRS reviewed comments suggesting that a beneficiary of an individual who has started required annual distributions should not be required to continue those annual distributions if the remaining account balance is fully distributed within 10 years of the individual’s death as required by the SECURE Act. However, Treasury and IRS determined that the final regulations should retain the provision in the proposed regulations requiring such a beneficiary to continue receiving annual payments.

The new proposed regulations include provisions for which Treasury and IRS are soliciting public comments, including provisions addressing other changes relating to RMDs made by the SECURE 2.0 Act. For details on how to submit comments, see the proposed regulations.

https://www.irs.gov/newsroom/treasury-irs-issue-updated-guidance-on-required-minimum-distributions-f... 

[qbteachmt]

Much of the main focus for the more recent notices has been to provide clarity and resolve EDB (eligible designated beneficiaries) and "beneficiaries of beneficiaries" mechanisms. The follow up from the comments reviewed that also led to the transition relief has mostly reiterated that the 2002 policies are still in place, only the timeframes are different, in many places.

"Since it was first added to the Code, section 401(a)(9) has always included the concept of a required beginning date, under which, once required minimum distributions began to either an employee or designated beneficiary, they were required to continue until the employee's entire interest under the plan was fully distributed, and these regulations retain this requirement. There is little indication in section 401 of the SECURE Act to suggest that Congress intended to allow distributions of an employee's account to temporarily cease for up to 9 years once annual required minimum distributions have begun."

"provides rules for determining the required beginning date for distributions and whether distributions are treated as having begun during an employee's lifetime. These rules are based on the rules in the 2002 final regulations, except that the rules have been updated to reflect the amendments to the required beginning date made by section 114 of the SECURE Act and section 107 of the SECURE 2.0 Act."

(my emphases)

As noted, pertinent details in this example scenario are:

Employee did not own 5% of company

Employee was still employed at the employer with the qualified plan

Employee died before reaching RBD on date of death

Taxpayer is not an eligible designated beneficiary

The 401(k) administrator did a direct trustee-to-trustee transfer to an inherited IRA account

The date of death falls under the 10-year rule

[qbteachmt]

Oh, I keep forgetting this part:

"My client, age 57"

We don't know your taxpayer's financial position at this time, of course. Waiting until the final year to take a full dsitribution likely will be quite a hit to their taxable income. I typically advise people to start looking at how they can control IRMAA starting around your client's age. They can take distributions until the year they are 62, for example, because 63 and 64 are the lookback years for IRMAA. That's only 5 or 6 years, then, to evaluate their projected taxable income and how the taxable distributions will affect them leading up to Medicare.

[Jim-from-Ohio]

QB.. can I ask you a question on IRRMA. say someone is 64 and makes about 400,000 AGI. they don't want medicare part B.  is it true that if they decline it they have to pay a medicare penalty for the rest of their lives.  what do you recommend this taxpayer do in this case if they want to not have part B and they have their own insurance elsewhere. is this even something remotely doable?

[qbteachmt]

You would first find out if their current/preferred insurance is an allowed substitute (through an employer?). There are circumstances where that's fine. And it matters if they want to delay both parts A and B?

Google this as a place to start:

can I delay medicare

As long as they follow through when circumstances change, they can "play by the rules" and avoid a life-long penalty.

The requirement to sign up is different than IRMAA. IRMAA is based on a 2-year lookback, and it can be appealed. Example: You sell a house with a large taxable gain or win a nice lottery/scratcher, but otherwise live mostly on Social Security, you can appeal the IRMAA increase, if it is clearly a one-off event and a bit unusual and won't affect your typical income.