It’s difficult to think about finances while grieving the loss of a loved one. However, if you inherit a retirement account, it’s wise to consult a tax professional immediately. Strict IRS rules, deadlines and penalties may apply.
If you’re a surviving spouse, the IRS will allow you to do a spousal rollover. This means, you can transfer your deceased spouse’s 401(k) or IRA into your own IRA, where the funds will continue to grow tax-deferred. If your spouse was 70 ½ or older, their annual required minimum distribution (RMD) must be subtracted before rolling the assets into your account. From that point on, the funds will be treated as your own. Early withdrawal penalties and required minimum distributions will be based on your age, rather than your spouse’s age. (Roth IRA’s and Roth 401k’s are never subject to RMDs.)
As a friend or other family member, you do not have the spousal option. You can, however, transfer the assets into a newly created inherited IRA and begin taking withdrawals immediately without an early withdrawal penalty. You will be liable for income tax on those withdrawals. You must keep an inherited IRA separate from any personal retirement accounts you may already own, and distribution rules will be different than those for your own accounts.
Whether you are a spouse or non-spouse, you can take a lump sum without paying a penalty. But the entire amount will be subject to income tax. Please be advised, there are specific tax consequences for handling inherited IRA vs. inherited 401k rollovers. You should consult with your tax advisor regarding rollover guidelines. (Earnings are generally tax-free on an inherited Roth IRA if the five-year holding period has been met.)
Depending on the individual plan stipulations, a designated non-spouse beneficiary may also leave the money in the original account and liquidate it within five years of the owner’s death or take distributions over their own life expectancy (known as the stretch option).
There’s much more to consider with inherited 401(k)s and IRAs. We can work with you, your attorney and your accountant to make the most of your inheritance or to ensure your own estate plan addresses your retirement accounts. Call Jordan Dechtman, your Denver wealth manager at 303-741-9772, email him at Jordan@JordanDechtman.com or visit our website at www.JordanDechtman.com to schedule an appointment.
Consult your tax advisor regarding your own unique situation.