What are the tax issues re the inheritance of a 401(k) plan?

In California as well as nationwide, it is not unusual for an heir to be the named beneficiary of a 401(k)-retirement plan. One positive factor of inheriting a retirement plan is that the beneficiary usually does not have to wait for the decedent’s estate to be probated to receive the retirement funds. If one’s inheritance includes a significant 401(k), complex rules and regulations may require a consultation with one’s estate planning attorney and, in some cases, with a tax expert.

There may be various options that can be exercised with respect to how one handles the receipt of the plan balance. Those options can have a significant tax effect. They will differ based on whether the beneficiary is a surviving spouse or not. Depending on whether the plan is a traditional one or a Roth plan, the beneficiary may have to pay taxes on the amount received.

No tax is generally paid on the Roth plan because the contributions consisted of funds that were already taxed. In either instance, the beneficiary may have the option of receiving distributions over a period of years to spread out the tax burden. However, in some plans the money will be distributed in one lump sum only. As a beneficiary, the recipient will not be subject to the usual 10 percent early withdrawal tax often required with a 401(k) plan.

A surviving spouse will have more options with the inheritance of a retirement plan in California and elsewhere. Both spouses and non-spouse beneficiaries may elect to roll the 401(k) over into an IRA to postpone the receipt of distributions until one reaches age 70 1/2. The tax ramifications may be quite complicated and will depend on the circumstances. It is recommended that a beneficiary obtain professional guidance whenever the amount is significant and where tax results are important.

Source: cincinnati.com, “Options for handling an inherited retirement plan“, Tom Cooney and Crystal Faulkner, June 7, 2017

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