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Here’s how to avoid costly mistakes if you inherit a 401(k) or IRA
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The New Road to Retirement




The New Road to Retirement


HERE’S HOW TO AVOID COSTLY MISTAKES IF YOU INHERIT A 401(K) OR IRA

Published Wed, Sep 8 20211:48 PM EDT
Sarah O’Brien@sarahtgobrien
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Key Points
 * Unless you meet an exception, inherited retirement accounts generally must be
   depleted within 10 years if the person died after 2019.
 * The 2019 Secure Act eliminated the ability of many beneficiaries to stretch
   out distributions across their own lifetime.
 * Spouses have more than one option for these inherited accounts.

Towfiqu Photography

If you inherit a retirement account, you may want to pause before making any
decisions on when and how to access the money.

Basically, the rules that apply depend on your relationship to the person who
died. Mistakes can be made, and depending on the specifics, they can be hard to
undo.



The 2019 Secure Act eliminated the ability of many beneficiaries to take
distributions across their own lifetime from inherited 401(k) or individual
retirement accounts if the original account owner died after Dec. 31, 2019.


MORE FROM THE NEW ROAD TO RETIREMENT:

Here’s a look at more retirement news.

 * Biden tax plan may lead to more Roth retirement accounts
 * How to handle Covid-related withdrawals from retirement accounts
 * 3% of near-retirees can answer all these Social Security questions

Unless you meet an exception — you’re the spouse or minor child of the decedent,
for example — those inherited accounts generally must now be depleted within 10
years.

Here’s what to know.


NON-SPOUSES WITH FLEXIBILITY

If the beneficiary is the minor child of the deceased person, the 10-year
depletion rule kicks in once they reach the age of majority where they live. In
most states, that’s age 18.

Before reaching that point, though, the child would have to take annual required
minimum distributions, or RMDs as they’re known, based on their own life
expectancy. (Those required withdrawals generally kick in for retirement savers
at age 72 based on the account owner’s expected lifespan.)



“So if you have a 10-year-old who takes RMDs, they’d do that until age 18 when
they’d flip to the 10-year rule,” said Brian Ellenbecker, a certified financial
planner with Shakespeare Wealth Management in Pewaukee, Wisconsin.

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Additionally, a beneficiary who is chronically ill or disabled, or one who is
not more than 10 years younger than the deceased person, can take distributions
based on their own life expectancy and are not subject to the 10-year rule. 


ALL OTHER NON-SPOUSE BENEFICIARIES

If you are a beneficiary subject to the 10-year depletion rule because you don’t
meet an exception, it’s important to consider how you’re going to meet that
requirement.

“There’s no set amount you have to take each year, it just has to be all
withdrawn within that 10 years,” said CFP Peggy Sherman, a lead advisor at
Briaud Financial Advisors in College Station, Texas.

The process basically involves setting up an inherited IRA and transferring the
money to it. This is the case whether the original account is an IRA or 401(k). 

There are a couple different things to consider in this situation, including
whether the inherited account is a Roth or traditional version.



Distributions from Roth accounts are generally tax-free, while traditional ones
are taxed upon withdrawal. (Be aware that if you inherit a Roth account that’s
been open less than five years, any earnings withdrawn would be subject to taxes
while the contributed after-tax amounts would still be tax-free.)

So if it’s a Roth and you won’t pay taxes on distributions regardless of when in
that 10-year period you take them, it may be worth leaving the money there until
year 10 so it can continue growing tax-free, Sherman said.

On the other hand, if it’s a traditional IRA or 401(k), it’s worth evaluating
the tax aspect of taking distributions. Because the money would be taxed as
ordinary income, taking a lot all at once could bump you into a much higher tax
bracket. Spreading out the distributions over the decade could minimize the tax
hit in any given year. 

> There’s no set amount you have to take each year, it just has to be all
> withdrawn within that 10 years.
> Peggy Sherman
> Lead advisor at Briaud Financial Advisors

If you do not empty the account within 10 years, any assets remaining in the
account could be subject to a 50% penalty.

Meanwhile, sometimes heirs end up with a retirement account via an estate — in
other words, they were not the listed beneficiary but end up with the account
when the estate goes through probate and assets are distributed.

In this case, different rules kick in. The account generally must be depleted
within five years if the original account owner had not started taking RMDs,
according to Vanguard. If RMDs were underway, the heir would essentially need to
keep those withdrawals going.


FOR SPOUSES

Spouses have more options when they inherit a retirement account.

The first is rolling the money into your own IRA. In this case, you would follow
the standard RMD rules — that is, when you reach age 72, you start making those
required withdrawals based on your own life expectancy.

“If the surviving spouse doesn’t need the income, this probably ends up being
the best option because it can potentially give them time for the money to keep
growing in the account,” said Ellenbecker, of Shakespeare Wealth Management.

However, he said, this also means you’d be subject to a 10% early withdrawal
penalty if you’re under age 59½ and withdraw money from that account.

The way to avoid that is to put the money in an inherited IRA and remain the
beneficiary. In this case, you would not be subject to the penalty.
Additionally, RMDs — which would be based on your life expectancy — do not have
to start until the deceased spouse would have reached age 72, Ellenbecker said.


Related

 1. Social Security cost-of-living adjustment could be at least 6% in 2022
    
 2. House Democrats propose new IRA and 401(k) rules for the rich
    
 3. House Democrats’ plan drops repeal of a tax provision for inheritances
    
 4. If you’re quitting amid the ‘Great Resignation,’ here’s what you need to
    know about your 401(k) plan
    
 5. Here’s how to avoid costly mistakes if you inherit a 401(k) or IRA
    


MORE IN THE NEW ROAD TO RETIREMENT

This is the age when Americans say they plan to retire
Lorie Konish
Social Security cost-of-living adjustment could be at least 6% in 2022
Lorie Konish
41% of Americans say it’s ‘going to take a miracle’ to be ready for retirement,
report finds
Jessica Dickler
Read More


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