In the wake of a loved one’s death, heirs often find themselves managing a variety of assets. One type of asset that deserves special attention is the “qualified plan.” A qualified plan, or qualified retirement plan, is an employer-sponsored plan that meets certain criteria established by the IRS. Examples of qualified plans include pensions, profit-sharing plans, money purchase plans, cash balance plans, SEP-IRAs, SIMPLEs, and 401(k) plans. When a worker retires, he or she must make an election about what to do with the funds. Options include taking a lump-sum distribution, taking periodic distributions, purchasing an annuity, rolling the money into an IRA, or leaving the money in the plan, if the employer permits.
Qualified plans generally have named designated beneficiaries who are entitled to the plan upon the plan owner’s death. It is essential for beneficiaries to review the plan as soon as possible, because they will be subject to certain plan election deadlines. A mistake or untimely action could trigger an enormous tax consequence, so beneficiaries should consider seeking the advice of a Colorado probate attorneyexperienced in dealing with decedents’ qualified retirement plans.
Reviewing the Plan and Other Documents
Any qualified plans must be reviewed as soon as possible after the decedent’s death, together with any other documents that might impact benefits. For example, wills and trusts may contain information that will affect the beneficiary designation for the retirement plan. The plan itself will provide information about available distribution election options, any distribution election currently in effect, and beneficiary designations in the event of the plan owner’s death. The plan may also contain provisions allowing beneficiaries to change investments or move to a new provider.
Beneficiaries of a decedent’s qualified plan must also be aware of any Required Minimum Distributions (RMD). The IRS requires plan owners to take such distributions, and there are a variety of options for doing so. Failure to take a Required Minimum Distribution, including in the year of death, results in a steep penalty: 50% of the amount that should have been withdrawn in that year. The death of the plan owner does not eliminate this penalty, so beneficiaries must be prepared to act in a timely fashion.
After-death distributions depend in part on whether the plan owner reached the “required beginning date” prior to death. At that point, the plan owner must choose between a lump-sum distribution or periodic payments determined by the plan owner’s life expectancy. The required beginning date depends upon the type of plan. For a traditional IRA, for example, the required beginning date is April 1 of the calendar year following the year in which the plan owner reaches 70 1/2.
Continuing with the example of a traditional IRA, if the plan owner had passed the required beginning date before death, the required minimum distribution must be made prior to the close of the calendar year in which the plan owner died; in that year, for purposes of the plan, it is as if the plan owner were still alive. Following a plan owner’s death, separate accounts may be created for each beneficiary. If each beneficiary wishes to use his or her own life expectancy as the basis for determining future required minimum distributions, the plan must be divided by December 31 of the year after the plan owner’s death.
Post-Mortem Minimum Distribution Rules, Elections, and Disclaimers
Following a plan owner’s death, there are a number of rules governing the payout of the remaining account value. Various rules may apply depending on whether the beneficiary is a spouse or not; whether the spouse is the sole surviving beneficiary; whether the qualified plan owner died before or after the Required Beginning Date; and whether the plan had a designated beneficiary.
Surviving spouses of deceased plan owners have unique rights so far as post-mortem distributions are concerned. A surviving spouse typically can roll over a distribution from a qualified plan to an IRA, just as its original owner could have. Similarly, a surviving spouse can roll over a distribution from the decedent’s IRA into another IRA. Under some circumstances, a surviving spouse may elect to treat an inherited IRA as his or her own. This is known as “spousal election.”
It is possible for a beneficiary to disclaim IRA benefits for tax purposes, allowing them to pass directly to a contingent beneficiary without any direction from the person making the disclaimer. An effective disclaimer must be in writing, irrevocable and made within a certain time frame. Typically, a disclaimer must be made within nine months of the decedent’s death. Whether disclaiming benefits from a decedent’s qualified plan is a good idea is a very fact-specific inquiry with significant consequences; the decision should not be made casually or without full information.
Elections that surviving spouses and other beneficiaries make (or fail to make) can carry penalties and large negative tax consequences if beneficiaries do not have detailed guidance on the implications of their choices. No one account should be considered in a vacuum, apart from other qualified plans and the rest of the estate.
If you are a beneficiary of a decedent’s qualified plan, you have important decisions to make and limited time in which to make them. For experienced guidance, contact the experienced estate planning and probate attorneys at Davis Schilken. Call us at 303-670-9855 to arrange a consultation at one of our two locations in The Denver Tech Center and Golden, Colorado. We look forward to working with you.