Are mandatory payouts enforced for an inherited 401(k)?

My father-in-law recently passed away unexpectedly. My wife is the sole beneficiary. Although he was still currently employed, he was 72 years old and had entered the phase of forced payouts from his pensions, 401(k), etc. So, I'm curious how the account will move forward at this juncture. I would assume the mandatory payouts no longer apply, since he is passed away. My wife and I are mid-30's and have been saving 10% of my own earnings for around 15 years, so I have a good start on my own 401(k), with plenty of time to continue doing so. So, let's say he had $200,000 in his 401(k). What are my options? Should I leave it be as a 401(k) and just change ownership? Should I roll it to an existing IRA (from a previous job) or roll it to a new IRA entirely? I know withdrawals will need to be taxed, but what about penalties to use it, for instance, to payoff an annoying $20K of remaining student loans? Or what if I wanted to use it for something like buying a car or building a home? We still have to work through the sale of his car and home, I realize those funds would be more "liquid" in paying off debts, but for the sake of this question, let's assume the sale of those items just washes out the debt-sale value leaving us with $0 gained/$0 lost.

Debt, Estate Planning, 401(k)
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March 2017

I am sorry for your loss.

You will be required to take required minimum distributions if you choose to not take the money as a lump sum. The treatment of Inherited retirement accounts, 401(k) or IRA's, is outlined in the IRS guidelines and publications 559, 575, and 590(b) depending on the type of retirement plan.

Generally, inherited (non- spouse) retirement (401(k), IRA) money can be rolled over into the beneficiaries name or you can take a lump sum or some type of distribution. Usually, people will roll the 401(k) and/or traditional IRAs into an account that must be labeled as an inherited IRA that will include the name of the deceased. The inherited IRA funds must be kept separate from other retirement accounts and monies, since your wife must take annual required minimum distributions (RMD) based on her age, for as long as there is money in the account. There are pretty severe penalties for not taking the RMDs, so make sure your tax advisor knows the details of the Inherited account  You can take more money out (pay off that loan), but any money taken as a distribution will be added to your income and taxed accordingly in the year of the distribution. If your father in Law had an annuity, retirement or non retirement, or a Roth IRA, they are treated a little differently and due to space and you not mentioning them will not go into them. Also, remember to make sure whoever does the tax returns (final individual and estate) for your father-in-law, make sure he took his RMD in the year of his death. If he was working, generally his work 401(k) is not included in his RMD calculation.  I strongly suggest you get some guidance from your tax advisor before making any transfers or filing any tax returns. Inherited Retirement money is not difficult to understand but the rules are very inflexible so get the right help to set up and understand what you can or should not do and the taxable nature of the decisions.

Below is an excerpted paragraph about a non-spouse beneficiary from the IRS website.

This is regarding an inherited retirement plan, inherited from someone other than a spouse."If the inherited traditional IRA is from anyone other than a deceased spouse, the beneficiary cannot treat it as his or her own. This means that the beneficiary cannot make any contributions to the IRA or roll over any amounts into or out of the inherited IRA. However, the beneficiary can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary."

Like the original owner, the beneficiary generally will not owe tax on the assets in the IRA until he or she receives distributions from it.

Beneficiaries of Qualified Plans

Generally, a beneficiary reports pension or annuity income in the same way the plan participant would have reported it. However, some special rules apply.

A beneficiary of an employee who was covered by a retirement plan can exclude from income a portion of non-periodic distributions received that totally relieve the payer from the obligation to pay an annuity. The amount that the beneficiary can exclude is equal to the deceased employee's investment in the contract (cost).

If the beneficiary is entitled to receive a survivor annuity on the death of an employee, the beneficiary can exclude part of each annuity payment as a tax-free recovery of the employee's investment in the contract. The beneficiary must figure the tax-free part of each payment using the method that applies as if he or she were the employee.

Benefits paid to a survivor under a joint and survivor annuity must be included in the surviving spouse’s gross income in the same way the retiree would have included them in gross income.

March 2017
March 2017
March 2017
March 2017