Good news for anyone who just inherited a 401(k) retirement account. They can now roll an inherited 401(k) to an Individual Retirement Account (IRA) tax-free. Prior to 2007, when the segment of the Pension Protection Act of 2006 involving non-spousal beneficiaries went into effect, only spouses were able to roll an inherited 401(k) into an IRA. As of the time of writing, any inherited 401(k) can be rolled over to an IRA.
Spouses who inherit a 401(k) have fewer rules to follow than a non-spousal beneficiary. They can roll the money into an inherited IRA and follow the rules that apply to that specific IRA, or simply roll it over into their own IRA.
If you are a non-spouse beneficiary and want to avoid cashing the 401(k) out all at once and paying the associated in taxes, you must roll the money into an inherited IRA that’s in the name of the original 401(k) owner, listing you as the beneficiary. For example, John Smith’s 401(k) must be transferred to John Smith’s IRA for the benefit of ("FBO") Jane Smith, daughter. Non-spouse beneficiaries cannot roll the amount over to their own IRA or an IRA in any other names. The beneficiaries for the inherited IRA can be one person or a group of people. If you do not set up this type of IRA, you must take the full distribution shortly after your benefactor dies and would have to count the distribution as income. It will be taxed at the corresponding income tax bracket. In some cases, this windfall may push you to a higher tax bracket, and you’ll have to pay more taxes.
Once the money is rolled into an inherited IRA, for both spouse and non-spouse beneficiaries, the beneficiary must take required minimum distributions (RMDs). The minimum distribution is calculated by dividing the balance of the IRA from the prior year by your single life expectancy divisor provided by the IRS that’s based on your age the year that you take the distribution. If the benefactor died before turning 70, you begin taking minimum distributions the year after death. It the original owner died on or after April 1 the year he turned 70, you must take the distribution that year. These distributions will count as income and will be taxed accordingly.
Things to Keep in Mind
Unless a person’s spouse consents to having someone else named as the beneficiary of a 401(k), the money will go to the spouse even if a child, cousin or friend is the named beneficiary on the account. The spouse at the time of death will be the presumed beneficiary and only that spouse will be able to waive that right and must do so before the account owner dies. If the account owner is single, the 401(k) will go to the beneficiary on the retirement account even if he names someone else as the beneficiary in his will.
- SmartMoney: New IRA Rollover Rules for Nonspouses
- Wall Street Journal: Family Feuds: The Battles Over Retirement Accounts
- The Money Alert: Inheriting A 401(k)
- Kiplinger: A Better Deal When You Inherit a 401(k) Read more at http://www.kiplinger.com/article/retirement/T037-C000-S002-a-better-deal-when-you-inherit-a-401-k.html#95lQUqucI79ymM5j.99
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