Inherited 401(k)s: 6 Questions Heirs Need to Ask

Did you know that an inherited 401(k) can be a lasting legacy, but the windfall should be handled carefully to maximize the inheritance and minimize taxes? Your relationship to the deceased and the 401(k) plan’s own rules can impact your options for managing the money. Step carefully, and you can avoid pitfalls of inheriting a 401(k).

Six 401(k) Questions Heirs Should Ask

Let us take a look at six key questions 401(k) heirs should ask.

1. What are the 401(k) plan rules? Contact the plan sponsor or company benefits department to sort out what options may be available to heirs for that particular plan. Some companies, for example, may allow heirs to keep the money in the plan and take beneficiary required distributions from it, while others may only allow an heir to take the money out in a lump sum. The rules depend on the 401(k) plan document written by the company.
2. What is the heir’s relationship to the original 401(k) owner? A spouse is automatically the sole beneficiary of the 401(k), unless he or she has given consent for other beneficiaries to be named, says Luscombe. Also, surviving spouses have more flexibility than nonspouse heirs on how they can handle the money. Namely, spouses can choose to take the money as if they originally owned it, and all the rules for original owners will apply to the inherited money.
3. Did the original 401(k) owner start required distributions? Determine whether the deceased had reached his or her required beginning date, or RBD, which is the date that owners must start taking required minimum distributions. The RBD for 401(k)s depends on whether the account owner was still working at the company. If the account owner had retired before age 70½ or was working at a different company, the RBD for the 401(k) is the April 1 after the owner turns age 70½. If the decedent was beyond that age and had not yet taken his or her required distribution for the year, heirs need to take that final distribution before the end of the year.
4. Should the money stay in the 401(k)? If a 401(k) plan allows heirs to keep the money in the plan, consider the pros and cons of doing so. In the 401(k), you might have access to lower-cost institutional shares or investment options, such as stable-value funds, that may not be available outside of employer plans.
5. Does a Roth conversion make sense? The IRS allows 401(k) heirs to convert the money directly into an inherited Roth IRA. If you make that direct transfer from a traditional 401(k) into an inherited Roth IRA, you may owe ordinary income tax on the amount converted. If the 401(k) is large, that tax bill could be hefty.
6. What if the account is a Roth 401(k)? Heirs may benefit from the tax-free treatment of money in a Roth 401(k), just as the original owner would have. It can be important to be clear whether you are inheriting a traditional 401(k) or a Roth 401(k).

Contact The Law Offices of Clifford M. Cohen Today!

For more information on inherited 401(k)s and related legal issues, please call the Law Offices of Clifford M. Cohen, and estate planning law firm in Washington DC at (202) 895-2799 to schedule a time to meet.