401K spouse survivor beneficiary

[ChiHoang]

I have a client who is a spouse survivor beneficiary of her husband 401K. Her husband passed away 6 years ago. She inherited the 401k balance of $1M. Few days ago she got a check to distribute the full amount less withholding tax. She called the plan and they said they distributed the balance due to the 5-year rule. She had no ideas of the 5-year rule, thought that the plan was under her name and she could wait until 72 years old to take the RMD.  Is there any way she can reverse the 5-year rule and select to take distributions based on her own life expectancy ? If so, what does she do with the distribution check ?

Thanks so much for your response.

[GodFather]

Has she called the institution that financial institution that distributed the funds to her?  Maybe they would be able to provide more immediate information on what her options are, if any.  I'm personally not aware of an opportunity to reverse the 5 -year rule, but maybe the firm has insight?

[ChiHoang]

She already called the plan institution, and they said she could not reverse and recommend her to put the distribution in Roth IRA. I hope that there is a way to reverse the 5-year rule.

[BobKamman]

She did not rollover the account to her own IRA?  She just left it sitting there in her late husband's name?  What if she opens an IRA now and deposits the funds into it within 60 days?  She can't rollover the tax withheld, but she can take that out of other funds if she has assets.  I'm not saying such a rollover can be done, I haven't had a client who has made that mistake, but I would research it further.  Maybe someone else here can tell us why it's not allowed.  

[IRonMaN]

Sounds like a major communication breakdown between your client and the investment company.  I have never personally run into the issue, but Bob was thinking the same thing I was thinking when I read this so I think it is worth looking into.

[ChiHoang]

The 401K plan is under her name. She transferred her husband's 401K balance to her name right after his death. I would think she can roll over to her own IRA account. I can file her tax return and recover the withholding tax. Can any one help me to confirm if I can do that ? Thanks so much for your help 

[IRonMaN]

Since the check came "a few days ago", I wouldn't count on getting that refund before the 60 day rollover window closes.  You are talking a 2022 return, e-filing is a month to a month and a half out and I don't think the return will be processed fast enough to get her refund check back in time.

[ChiHoang]

I just want someone to confirm that my client can roll over the distribution check to her own IRA account. She does have cash to roll over the withholding tax. And I will file her tax to get the refund of withholding tax later.

Thanks.

[IRonMaN]

"I just want someone to confirm that my client can roll over the distribution"

Or, instead of waiting, you could always try doing a little research on the issue.

[rbynaker]

I would stay out of it.  You could try to research but if this isn't your wheelhouse it can be hard to even know what questions you need to ask, let alone follow the breadcrumbs to the right answer.  Find a local retirement expert and refer your client to them.

Personally, I've never heard of anyone opening an "Inherited 401(k)" account.

[ChiHoang]

I thought this is a tax question, not retirement question. MAYBE SOMEONE CAN ANSWER ME. I think she should be able to roll over to her own IRA account within 60 days as one of the options for spousal beneficiary. The institution just originally placed her account in the 5-year rule by default.

Thanks.  

[GodFather]

As I mentioned previously, I've never run into this situation in my practice.  With that said, I did a little research and came across this article.  Based solely on what I read, it looks like the roll-over into her own Roth IRA may be an option.  Since I don't know all the specifics, I can't comment for sure though.  Good luck. 

What Is the Roth IRA 5-Year Rule? When It Applies, Whom It Affects (businessinsider.com)

The 5-year rule for inherited Roth IRAs

The final 5-year rule applies to inherited Roth IRAs. Roth IRA beneficiaries can withdraw contributions from an inherited Roth account at any time (in fact, they're required to). But to withdraw earnings tax-free, the account must have been open for at least five years when the original account-holder died.

If the account hasn't been open that long, there are a few options:

• Disclaim the inherited assets. You can choose not to accept the funds if you don't need the money or don't want to deal with the tax consequences.
• Withdraw the money in a lump sum. You'll have to pay taxes on the earnings portion of the account all at once, but this might be better if you're in a low bracket now.
• Withdraw funds annually based on your life expectancy. This option is only available to surviving spouses, minor children of the account holder, disabled or chronically ill people, and beneficiaries who are less than 10 years younger than the deceased (for example, a sibling). The beneficiary's life expectancy is based on the IRS Single Life Expectancy Table.
• Roll the inherited funds into your own Roth IRA or a new Roth IRA account. This option is only available to surviving spouses.
• Delay withdrawals. You can leave the money in the account until the 5-year mark has passed. The Setting Every Community Up for Retirement Enhancement (SECURE) Act mandates that, for most beneficiaries, inherited IRAs must be emptied within a decade. The beneficiary owes a 50% penalty on any assets left in the account at the end of the 10th year.

[ChiHoang]

Thank you for your research, but it's a regular 401K plan, not Roth IRA. My question is whether she can roll over her inherited 401k plan (regular) to her own regular IRA so she does not get hit with tax on $1M distribution.

[BobKamman]

Can we all agree that an inherited 401(k) can be rolled over to an inherited IRA, without it being a trustee-to-trustee transfer?  She really doesn't want to roll it over to a Roth IRA, since that will still make it taxable.  The disadvantage to taking the distribution and then depositing it to a new IRA account, is that the tax has been withheld.  Would the payor accept return of the check with instructions to issue a new check to the IRA trustee?  

For less than helpful advice, you can check the Schwab website, which says "If your employer made your rollover distribution check payable to you rather than to Schwab, see our Rollover IRA common questions to find out what to do."  Just try to find that part of the website.  Maybe it was on the TD Ameritrade website, before the merger.  
 

[ChiHoang]

That's my exact question. Can anyone confirm that an inherited 401(k) can be rolled over to her own IRA though her institution sent her a distribution check based on the default 5-year rule ?

Thanks 

[IRonMaN]

Where are you rolling it over to?  Maybe you want to check with them to see if they are going to take the money in as a rollover.

[BobKamman]

Maybe if the institution that manages the 401(k) also offers IRA accounts, they might be more willing to rescind the payout and allow a rollover if it went to an account opened with them.  

[qbteachmt · Accepted solution]

This is all very confused. For instance, you mention the 5-year rule, but the original owner died 6 years ago? 2017? What is the year of death? I believe the rule is to empty the account by the end of the 5th year after the year of the date of death, similar to how it reads for nonspouse:

"At any time up until 12/31 of the tenth year after the year in which the account holder died, at which point all assets need to be fully distributed."

And that should include rolling it to an Inherited IRA, then into her own IRA. That means now doing so by making up the withholding difference, depositing the gross. OR, pay taxes on the withholding as a partial distribution, of course.

Had the deceased spouse been taking RMDs, or reached that age? Did/has she continued that? He fell under the 70-year old rule. For any provision and reference you read, pay attention to if it is impacted by the SECURE Act, so you know if it falls under old or new rules.

You need to know specifics, and details, and what applies depending on the year in question. You mention she thought the plan was in her name, but "plan" doesn't apply. It's account that is important. Did she have it in a 401(k) account in her name, or as Beneficiary in his name? She could have rolled it into a Traditional IRA; talking about Roth is talking about a taxable conversion. 401(k) to Trad IRA is not a taxable event. She is not trying to reverse the 5-year rule. She is trying to know the options.

There are resources all over the web, such as:

https://www.investopedia.com/inherited-401-k-rules-to-follow-5425958

https://www.fool.com/retirement/plans/401k/inherited/

https://www.cnbc.com/2021/09/08/heres-how-to-avoid-costly-mistakes-if-you-inherit-a-401k-or-ira.html

"If the account holder died before 2020, and therefore is not subject to the changes in the SECURE Act, you can learn about distributions options in our Inherited IRA Brochure that covers scenarios prior to the SECURE Act,"

https://www.schwab.com/resource/youve-just-inherited-a-retirement-account

[ChiHoang]

Thank you for all your help.

I was able to talk to retirement expert at her institution and roll over the distribution to her inherit IRA without tax implication.

[qbteachmt]

Yay!