401K with no beneficiary - Multiple problems | Ed Slott and Company, LLC

401K with no beneficiary - Multiple problems

72-year-old retiree passed away, leaving a Fidelty IRA with no beneficiaries. At the time of death, she was receiving regular RMDs. The personal representative, a young relative, requested a lump-sum payment to the estate. Payment has been made and deposited to the estate bank account. Under the terms of the will, 6 relatives will inherit in equal shares. My questions:
1. Is it possible to un-do (or more accurately, cure) the lump-sum distribution and create an estate IRA?
2. If not, and the heirs all are given their full shares, how is their tax liability characterized? Is it taxed as income using their individual tax brackets, or is it taxed as income with some sort of penalty?

  1. No, there is no way to undo the taxable lump sum distribution. In fact, almost all qualified plans left to an estate is going to trigger a lump sum distribution  per the plan's procedures. Your post title shows a 401k, but the text indicates IRA. If a 401k, the IRS Regs do not permit a direct rollover to an inherited IRA for non designated beneficiaries, except for a qualified trust. Therefore, leaving a qualified plan to an estate is even worse than leaving an IRA to an estate because an inherited IRA can be assigned to the beneficiaries of the estate, and an inherited qualified plan cannot.
  2. The estate executor should pass the lump sum distribution to the will beneficiaries and issue a K 1 to each beneficiary, who then reports the income on their personal 1040 and it will be taxed at their personal marginal tax rate. There is no penalty.
  3. If the beneficiaries are unhappy with the executor, if a 401k the executor probably had no choice, but if it was an IRA the executor could have avoided the lump sum distribution and assigned the inherited IRA account to the will beneficiaries. So it's better for the executor if it was a 401k. But it would have been better for all had the participant named her beneficiaries instead of leaving the account to her estate.

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