By ALAN KONDO, CFP, CLU
Inheriting money from a deceased person’s 401(k), 403(b), or 457 plan? Your options in managing those assets depend on whether the deceased was your spouse and whether he or she had already begun taking Required Minimum Distributions upon reaching age 70½. It is important to pay attention to IRS rules that govern this type of bequest.
Considerations for Spouses
Spouses have three options when it comes to inheriting assets from a qualified defined contribution retirement plan:
● Keep it in the plan.
● Take the assets as a lump sum.
● Transfer the assets into their own IRA.
As long as your spouse’s plan permits, you may keep the assets in the plan as a “beneficiary account” and continue to enjoy its tax-deferred status. If your spouse had already begun taking Required Minimum Distributions, you must continue to take them at least at the same rate. If your spouse had not yet begun taking RMDs, you can delay taking them until the year your spouse would have turned age 70½.
If you take a lump-sum distribution, you will be required to pay income taxes on the full amount. Twenty percent of the amount due to you will be withheld automatically and sent to the IRS for taxes.
If you transfer the assets into an IRA (called an “IRA Rollover”), you are not required to pay federal estate or income taxes if the assets are left intact within the estate. After reaching age 70½, you must begin RMDs based on your life expectancy. If you have already begun taking RMDs, you must take your annual distribution before transferring the assets into your account.
This last option is likely to give you the most flexibility and control. Having the assets in your own IRA gives you more direct and rapid access to the account (rather than going through your deceased spouse’s former employer), and the costs within an IRA are often significantly lower than a 401(k), which results in better performance.
Considerations for Non-spouses
Non-spouses also have three options:
● Keep it in the plan.
● Take the assets as a lump sum.
● Roll over the assets into a Beneficiary IRA.
Your option to keep it in the plan is dependent on plan guidelines: Some will allow you to keep the account in the plan; some will require you to withdraw the assets. If the deceased had already begun taking RMDs, you must continue taking them at the same rate or faster. If the deceased had not yet begun taking RMDs, you must begin taking distributions by the end of the year after the person died.
As with the spousal scenario, taking a lump-sum distribution will necessitate the payment of income taxes on the full amount. Twenty percent of the amount due to you will be withheld automatically and sent to the IRS.
Rolling the inherited IRA into a Beneficiary IRA may be the best option for many heirs. Ironically, many heirs are not told that they have this choice. A Beneficiary IRA allows the heir to transfer the IRA with no taxes, and allows the IRA to continue to grow tax-deferred for the heir’s life expectancy. You will have to take annual Required Minimum Distributions even if you are younger than 70½, but if you are young, they can be relatively small (1 to 2% per year) and the rest can can continue to stay in the account and grow tax-deferred. If you are opening a Beneficiary IRA, the account must be titled in a specific way, with the name of the original participant first, with you listed as the beneficiary.
Because the rules are complicated and the consequences of a seemingly minor error can be thousands of dollars in unnecessary taxes, consult with a Certified Financial Planner™ to answer any questions you may have before submitting the paperwork.
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The opinions expressed above are solely those of Kondo Wealth Advisors, LLC (626-449-7783, info@kondowealthadvisors.com), a Registered Investment Advisor in the state of California. Neither Kondo Wealth Advisors, LLC nor its representatives provide legal, tax or accounting advice.