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Retirement Plan Considerations Following the Death of an Employee   

 

The death of an employee is a stressful time for business owners and co-workers. In the midst of this, there are some important dates and retirement plan considerations to keep in mind. This article summarizes required distribution timelines and deadlines, as well as retirement plan steps following an employee death. And it offers guidance for slowing distributions from an account when that is desired.

 

Required Minimum Distributions

Many considerations are related to Required Minimum Distributions (RMDs). All retirement plan accounts, except for Roth IRAs, are subject to RMD requirements. In general, as employees attain age 70½, the first RMD payment is required by April 1 of the following calendar year. This April 1 is the Required Beginning Date (RBD). Employees who do not own more than 5% of their employer, and who work after 70½, are allowed to choose to postpone RMDs until they retire. (Employees who own more than 5% of an employer may not make this election to postpone.) The first Required Beginning Date is April 1 following the 70½ year. After this first year each year’s RMD must be paid out by December 31 of the same year. Each year’s RMD is determined using the prior year December 31 Account Value divided by Life Expectancy (as determined using IRS tables).

As long as a person has earned income, he / she may continue to make contributions after Age 70½ to retirement plans and to Roth IRAs, but not to traditional IRAs. Designated Roth Contribution Accounts in a 401(k) plan are subject to the usual RMD requirements. Employees may, however, roll over Designated Roth Contribution Accounts from a 401(k) plan to a Roth IRA to avoid all RMD requirements during the owner’s lifetime. Withdrawals from Roth IRAs, either by the original account owner, or after death, by a beneficiary, are tax-free (both principal and interest or investment earnings) when withdrawn after the account owner becomes 59½ (or would have become 59½), and after the account has been in existence 5 years. For a beneficiary, the 5-years-in-existence rule is not shortened when the account owner dies sooner.

Failure to take RMDs causes a plan to lose its favorable tax-qualified status and leads to a penalty each year that is required to be reported on the employee’s tax return. The penalty is 50% of the amount of the RMD not paid.

After an Employee Dies – When Spouse is Beneficiary

When an employee dies before the Required Beginning Date, a Surviving Spouse Beneficiary has several options. The slowest payout can be achieved when the Surviving Spouse treats the account as his own / her own and selects a new Beneficiary. When the Surviving Spouse attains 70½, the slower of the Joint Life and Last Survivor Life Expectancy table or the Uniform Lifetime table (used when non-spouse beneficiary is more than 10 years younger) is used to calculate RMDs. The ages of the Surviving Spouse and new Beneficiary are used, with annual recalculations, which slows distributions and lengthens the life of the remaining account.

Rather than treating the account as his own / her own, the Surviving Spouse could roll over the account internally or to another retirement plan or IRA, but in this case a new Beneficiary may not be named. If RMD payments begin by December 31 after the later of the year of death, or in the year the original owner would have attained 70½, payments may be made using the Single Life Expectancy table using the age of the surviving spouse. If RMD payments have not begun by this December 31 date, the entire account must be distributed by December 31 of the 5th year following the year of death.

Surviving spouses below age 59½ may leave funds in the retirement plan to avoid 10% penalties for pre-59½ withdrawals, and to retain participant loans (which IRAs cannot support).

When an employee dies after the Required Beginning Date, a Surviving Spouse Beneficiary may treat the account as his own / her own and select a new beneficiary. For the slowest pay-out, distributions should resume when the surviving spouse attains age 70½ using the Joint Life & Last Survivors Life Expectancy table using the ages of the Surviving Spouse and the new Beneficiary.

Rather than treating the account as his own / her own, the Surviving Spouse could roll over the account internally or to another retirement plan or IRA. In this case a new Beneficiary may not be named. If RMD payments begin by December 31 after the later of the year of death, or the year the original owner would have attained 70½, payments may be made using the Single Life Expectancy table. Either the age of the Surviving Spouse Beneficiary or the age of the original owner may be used. If RMD payments have not begun by this December 31 date, the entire account must be distributed by December 31 of the 5th year following the year of death.

After an Employee Dies – When the Beneficiary is not the Spouse

When the Beneficiary is a non-spouse, and the employee dies before RBD, the Single Life Expectancy table is used with the Beneficiary’s age. For each succeeding year this Life Expectancy must be reduced by 1.0; life expectancies are not recalculated. This payout continues to serve as the minimum, even if the non-spouse Beneficiary dies.

When the Beneficiary is a non-spouse and the employee dies after RBD, the Beneficiary uses the Single Life Expectancy table with the age of either the Beneficiary or of the deceased owner, using the owner’s age immediately before date of death. Again, this life expectancy must be reduced by 1.0 each year, and life expectancies may not be recalculated.

Timing is Important

A Surviving Spouse beneficiary below 70½ may choose to suspend RMDs until the Surviving Spouse attains 70½. Any other beneficiary wishing to slow down distribution requirements, however, must commence distributions by December 31 of the year following the year of death.

When a non-spouse Beneficiary commences RMDs by December 31 following Year of Death, payments may be made using one of the life expectancy approaches. After that, the only RMD option is for the non-spouse Beneficiary to withdraw the entire account balance by December 31 of the fifth year following the Year of Death.

Because of this deadline it is VERY IMPORTANT for employers to promptly notify JULY of the death of any employee with funds in a retirement plan.

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All of us at JULY appreciate the opportunity to serve you and the employees in your plan. Please contact your JULY Client Service Manager if you have questions or for more information.

By Jim Hudson, Chairman, July Business Services