Inherited non-spousal 401k, total lack of RMDs and Waiver questions | Ed Slott and Company, LLC

Inherited non-spousal 401k, total lack of RMDs and Waiver questions

Hi all,

I have spent hours reading through the forums, trying to gather information for my particular situation. Although my situation is not entirely different from what I've read, I do have some different nuances that apply, and have been receiving some conflicting information as I speak with multiple CPAs for guidance.

I inherited a 401k from my dad, who died prior to 70 in 2005. The Custodian created a 401k in my name after his death, and documentation I received from the custodian was that I could take the funds out, or leave it in there and watch it grow. The 401k has changed custodians a few more times over the years, and I was never alerted to needing to close out the account or take RMDs, through all of those changes. No documentation, no letters, and custodian changes went through every time, with no alert. This 401k has been through 4 different custodians.

The latest custodian who took over the account maintenance this year sent me a letter the end of March stating that the account needed to be closed out as I was required to take the full amount out, and 2 days later I received the check (minus 10% fed tax), along with a letter stating I had pay the IRS 50% in penalties and closed out the 401k. As I tried to get more information, I was also informed I was unable to retrieve any previous missing statements for the previous years and the custodian stated the only way I could receive that information was if I was filing for divorce and it was needed for our divorce proceedings.

I'm trying to gather the right direction from multiple accountants, and everyone has a different thought on what to do go forward (file now, file next year, go to court, request an official ruling from the IRS, etc).

Questions:

1. Do I pay the estimated taxes that I'll owe for this amount immediately? To show that we found an error and are trying to correct it immediately?

2. Since I've already filed my 2018 taxes, the accountant is recommending I wait until next year to file the 5329 along with my 2019 taxes. He stated that it will draw less attention and perhaps make requesting a waiver easier. However, I want to find closure to this issue as soon as possible so I don't have to worry about this for an entire year and then wait to see if a waiver is approved. With that in mind, what should my next step be? 5329 for 2009 along with a 1040X for that year as soon as possible?

3. Any recommendations on how to format the waiver letter and what detail to put in here? I have received incorrect advice from the custodians, and based on the lack of communication and alerts from all of the custodians, I really had no idea I needed to take action on the account to close it out and take RMDs. Any documentation I received from the custodian was either my quarterly/yearly statements, or the generic fund allocation recommendations and fund performance newsletters.

Thanks so much in advance for your guidance!

  • There are potentially dozens of questions connected to this. It is surprising that 4 different custodians were apparently clueless over the requirements of their plan to meet IRS RMD requirements per Sec 401(a)(9). Without access to the plan provisions in 2005, it is not possible to know whether the 5 year rule or life expectancy RMDs were indicated, or if you would have been able to make an election by the end of 2006. But no distributions at all during this period constitutes a serious plan error. How costly this is to you of course depends on the amount you are receiving.
  • Do not worry about the penalty waiver. If you file the 5329 forms correctly any penalty will be waived by the IRS. Form 5329 is it's own tax return so you will not need a 1040X. You should assume that the 5 year rule applied for purposes of the 5329 forms. Because an IRS Reg. requires 100% of the account to be distributed in 2011 (2009 does not count due to RMD waivers for that year), and if not done in each year thereafter, the 5329 should be filed for each such year 2011-2018. To complete each year's form the year end balance (current year) is needed since that is the amount that had to be distributed. Since the value at year end cannot be attained in your situation, the 5329 for each year might show the value including withholding actually distributed this year, with an explanation included in the reasonable cause statement. That statement will be the same for each year. The IRS will almost certainly waive the penalty. You will need to download the applicable edition of Form 5329 for each year from the IRS website under prior year forms. While each form only has 4 lines to complete in addition to the heading info, and each one will be approx the same, all you need to do is review the final page of the 5329 Inst for how to complete each line. It is not intuitive so read that page carefully. About the only way you would not receive the waiver is by messing up the 5329.
  • A bigger issue is that if this account is of any size, it will all be taxable this year and will probably increase your marginal rate. That said, you saved taxes for years because of their errors and tax rates are now somewhat lower so in the end you may not be much worse off, and you will have these proceeds to cover the additional tax. There is NO 10% early distribution penalty for inherited accounts. 
  • As for estimated taxes, there will be no underpayment penalty if you pay in 100% of your tax liability for 2018 (110% for higher incomes), but you might have to pay June, Sept and Jan, 2020 estimates to get to that figure.
  • With respect to the "reasonable cause" explanation statement with each 5329, all you need to do is state that the plan never contacted you about your RMD requirements and issue a lump sum distribution without notice or explanation in 2019. No additional detail is needed. Include a copy with each 5329 filed. Once you do the first 5329, the others just follow suit.
  • Any additional questions please advise. I assume you don't wish to contest the plan's actions to the plan or the DOL. Probably not worth it unless the amount is very large. 

 

  • There were 3 apparently clueless custodians, and the 4th (and final) custodian had take these actions when they took over Jan 1 2019.   Without going into detail, these are big name custodians that provide these services to enormous and very well known companies.   I don't have detail as to whether I could fall under the life expectancy RMD, but I suspect that since dad was not of age to receive RMDs from his 401k at his death, and I am his child, that the 5year rule applied.
  • Based on my experience with 2 accountants so far, I'm more nervous about the 5329 not being filled out appropriately and am concerned we won't fill out those 4 lines correctly.   I was directed to file only a single 5329 for 2019, as this is the year that I received the RMD (account in full).    I do not have *exact amounts for all of the year-ends, but do have them to the closest thousand.  Should those numbers be used, or should I simply use the final exact amount that was sent to me this year at account closure for each of the 2011-2018?  
  • Based on this article in the mailbag, https://www.irahelp.com/slottreport/so-you-missed-required-minimum-distribution%E2%80%A6 - it states "You should file Form 5329 along with your annual return for the year the missed RMD was finally distributed. "   Should I only file for 2019 since that's when I received the RMD?  Or one for each year 2011-2018 as you stated?  This is where there is much confusion.
  • Is there a negative side to completing and sending the 5329's separately as soon as possible, just to get this over with?  Again, I'm looking for closure.
  • Do I need to provide any other supporting documentation with the 5329, such as a copy of the check or copy of the letter the custodian provided stating the amount was being dispersed?
  • Will I receive a response from the IRS regarding the various 5329's that I file a waiver for?  
  • How would I even be able to contest the plan's actions and what would I gain?  Based on my phone conversations with the latest custodian, they are providing as little information as possible, and suspect it's to protect themselves or the plan.   The amount at play here is 6 figures.  My accountant advised me that the plan rules of the final custodian is what is at play here.  He advised me to deposit the check immediately and place it in a liquid fund so that I could have immediate access to it for the various situations that come up due to the custodian's actions (taxes, penalties, etc).  Therefore, the funds have been dispersed and I have them elsewhere.  

Many thanks again! 

  • Either life expectancy or the 5 year rule could have applied, but without knowing the plan provisions we'll never know. GIven the incompetence, we can't assume the lump sum distribution arose out of the 5 year rule being applied late, some other provision, or just arbitrarily deciding to liquidate the account.
  • As long as you carefully read the final page of the 5329 instructions and understand them, the 5329 is not difficult.  You would be more likely to get it right than most tax preparers. That said, the IRS receives thousands of incorrect 5329 forms requesting penalty waivers each year and it rarely changes their decision to approve the waiver. My earlier recommendation about how to file the 5329 forms given a 5 year rule situation came from noted IRA authority Natalie Choate. So that is the best solution, but I doubt that very many people actually complete the forms in that manner. They improvise, and you could too if you wanted to. For example, you could do the 2011 form for the balance that year, and do just one more for 2018 for the difference between the ending balance and the one shown on the 2011 form. That would not risk the current waiver approval, but it would not start the statute of limitations for those year where you did not file a 5329. If you file them all, for lack of exact numbers you could use the nearest 1000 figures you have for the respective years.
  • The Slott article likely assumed a 5329 for the year for which the 1040 is also being filed. In that case, it would be attached, but for prior years in which a 1040 has been filed, doing the 5329 by itself is fine, since a 1040X has no function in those cases. You do not need a 5329 for 2019, since there is no balance left at the end of 2019, so no 2019 penalty waiver needed. For 2019 you will have to report the 1099R showing the taxable income from the lump sum distribution, that is all.
  • Filling the 5329 forms soon is preferable to waiting, and then having to revisit this again after things get fuzzy. It is also better to file past year 5329 forms outside the normal filing period, so the upcoming couple of months are ideal.  I suspect your accountant just preferred to put this off.
  • You do not have to send other supporting info. A copy of the distribution check would not hurt though.
  • The IRS sometimes responds, sometimes not. If they do, it would probably be several months from now. They may want to wait until the 1099R is issued next January. They are not consistent. If they do not respond, just treat that as good news.
  • No clear answer, but contesting what they did would be a very long haul, and you would probably need a benefits attorney at hundreds of dollars per hour. Probably not worth the cost given that you already benefited from 13 years with no RMDs at all which boosted your tax deferral and gains on the account. You may need the distribution to fund the tax bill next spring for this lump sum distribution. I think the odds that the plan discovers an error through self audit or even a DOL audit (they do very few) that allows you to return some of the distribution is very slim. 
  • Finally, when beneficiary RMDs or other distributions result in higher taxes, if you are not maxing out your current pre tax retirement plan, you could use some of the proceeds to increase pre tax contributions. That will offset some income at the elevated tax rates, and place some of the proceeds into your own retirement plan for which your own RMDs are a ways away and will be smaller as an account owner using the Uniform table when the time comes.

Your recommendations based on information Natalie Choate does bring up a good point that I'd like clarification on.  You mentioned putting the original amount on 2011, and then the final amt on the 2018.  Putting in the entire RMD amount every year from 2011-2018 puts me at a disadvantage if my waivers are not approved. For example, if I put in $100k in the form each year, and the waiver is denied, I'd have to pay 50k (50% of that amt) each year, totally bankrupting me, where I would end up paying $400k in penalties on a $100k 401k.   

  • Instead, do I put 2011's amount for 2011, the difference between 2012 and 2011's amount for 2012, and so forth, so that the total when all is said and done still equates the final distribution?
    • (From part of her book:  If an RMD has been missed, do you deduct the missed RMD from the “prior year-end account balance” when computing the RMDs for subsequent years? That is a “reasonable and appropriate” way of computing such later-year RMDs, at least for a qualified retirement plan, according to Reg. § 1.401(a)(9)-5, A-3, and Rev. Proc 2013-12, “Employee Benefit Plan Qualification Requirements—Employee Plans Compliance Resolution System,” 2013-4 I.R.B. 313 (12/31/12), Appendix A (“Operational Failures and Correction Methods”). Presumably this also applies to IRAs, though there is no separate IRS pronouncement on that subject. In general, the IRS must assess taxes within three years after a required return.")
  • And let me just state how incredibly appreciative I am of your guidance, it is really helping me better navigate this unusual and stressful situation I'm in.  Thank you again.

  • Doing just two of these forms is a compromise, but doing all of them is preferable because it starts the 3 year statue of limitations for every year, not just those 2 years.
  • As the IRS Reg cited by Natalie Choate indicates, after 5 years the total value of the account becomes the RMD for that year. I doubt that many people understand that, but their waiver requests are still granted for the years that they do file a 5329. If you want to go the more accurate way, file one for each year and just make your best guess what the balance was at the end of each such year. That starts the 3 year statute of limitations for every year. Since the IRS continues to be very lenient, accepting almost any reason as a valid reasonable cause, better to deal with the entire situation now and have each year approved. Again, if you do not file a 5329 for any year between 2011 and 2018, you are not getting a waiver for that those years.  So I would file for each year, and just take your best guess at the account balance at the end of each such year.
  • With respect to your quoted paragraph from her book, although hardly anyone does this, that paragraph applies to the life expectancy method. For the 5 year rule, the IRS Reg that specifically makes the entire balance of the IRA the carryover RMD is more specific and overrides the quoted statement. 

I hope you have time for one more question on the 5329?  Under specific instructions:      "Joint returns. If both you and your spouse are required to file Form 5329, complete a separate form for each of you. Include the combined tax on Schedule 4 (Form 1040), line 59."

  • I file jointly with my spouse.  However, the 401k distribution was paid to me, as it all was only in my name.  Do I still have to have these forms filled out with my spouse's information as well?  Right now I have them filled out with only my name and SSN on it.

Thank you again! 

No 5329 is needed for your spouse since only you inherited the 401k and had an RMD obligation. This applies even though you are filing jointly.

I wanted to provide an update.  Thanks to your guidance, Alan, I was successful in getting the 50% penalty waived for each year that I filed the 5329 and requested the 50% penalty waiver  (2011 - 2018).  I received initial letters from the IRS saying they needed further time to review my requests.  3 weeks later, I received responses from the IRS as separate letters for each year, stating they approved my request for the 50% penalty waiver.THANK YOU SO MUCH for your help and guidance, a huge weight and worry has been lifted off of my shouldersIssue solved :)

Great. And thanks for posting this update because it is helpful to us to keep track of what the IRS actually does in certain situations. In your case they were consistent with their past actions.

 

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