How much will I have to pay in taxes on an inherited 401k?
I inherited my diseased father's 401k. It was $1,790,000.
Thank you for your question and sharing some information. I am sorry for your loss. Short answer, it depends. It will depend on the age your father passed away and if he had started taking RMD's. The 401(k) plan could have specific rules about how and when you must take the money out versus and inherited IRA perhaps. The total value of your father's estate will also have to be considered as there could be state or federal estate taxes due.
I would encourage you to consult with a CFP professional, Estate planning attorney, and a tax professional. Working with a team like this will educate you and give you a lot of information so you can make the right decisions moving forward. The size of your father's 401(k) is somewhat more than most tend to be, getting some solid advice will be important.
If you have any further questions please feel free to contact me.
Very sorry for your loss. That is never an easy thing to deal with.
As to your question, assuming it is a traditional 401k (not a Roth), you essentially have two (possibly three) options: (1) Take the lump sum, (2) roll it into an inherited IRA, or (3) keep it where it is.
Option 1 may be unappealing here given the size of the account. Option 3 may or may not actually be an option - you would need to check with the Plan Administrator, because some plans require beneficiaries of participants to take the money out either immediately, or over a certain period of time.
You will likely have to start taking required minimum distributions (RMD) on the account, and those distributions will be fully taxable at the federal and state (if applicable) level. The amount of the distribution will be added to your income, so the actual amount of tax due will be dependent on your total income for the year (which is why option 1 above is probably not particularly appealing because it would almost certainly bump you into the highest tax bracket).
Additionally, the rate at which you have to take the RMDs may depend on whether your father was already taking RMDs or not, his age at death, and various other factors. You can learn more about the RMD rules as they relate to retirement account beneficiaries in IRS Publication 590-B (https://www.irs.gov/pub/irs-pdf/p590b.pdf). There is also additional information here (https://www.schwab.com/cms/P-1625576).
Finally, you definitely want to make sure you handle it properly because if you withdraw less than the RMD in any given year/period, you can be hit with a 50% penalty on the amount you should have withdrawn but did not.
The above is rather generalized, and given that there is additional information that could affect the RMDs coupled with the 50% penalty that you may incur if you do not satisfy the RMDs, I would suggest that you speak with your CPA and/or financial planner regarding the rules as it relates to dealing with you father's account.
Hope that helps and best of luck.
You should not need to pay any taxes if you have rolled over the funds into an inherited IRA. In setting up the inherited IRA, you should be named the primary beneficiary. The rollover is a tax-free event if the account is transferred properly. If you took a full distribution from your dad’s IRA, then the total amount could potentially be taxable. In this case, that amount would be taxed at the highest federal and state income tax rates.
Once the funds are in your inherited IRA, the IRS requires you to take a distribution each year, starting with the year after your dad passed away. A financial advisor or CPA can help you calculate the distribution amount; the distribution has to be made before December 31st each year. This distribution is fully taxable at ordinary income rates at the federal and state levels. It is added to other income you have earned during the year.
It is very important that the required distribution is made each year—otherwise, the IRS may assess a penalty equal to 50% of the required distribution amount that was not taken.
Ultimately you will have to pay income tax on the distributions as you take them if these funds were pre-tax. However if you roll these funds over into a beneficiary IRA, you may be able to defer those taxes. There are requirements that you must take out a required minimum distribution, even if you are not age 70 1/ 2, if you did choose to roll these funds over into beneficiary IRA. Check with the delivering company of the funds for possibilities that may fit your situation. And don’t be afraid to ask any questions!
My condolences in the passing of your father.
In answering, I’ll assume that you are the sole “designated” primary beneficiary and that all your father’s contributions to the 401(k) were pre-tax.
Any amounts you withdraw (“distribute”) will be taxed as ordinary income…both federal and state (if applicable). So the income tax you end up paying will depend on your other taxable income and how much you distribute in any particular year. If you distribute large amounts, you could easily push yourself into one of the higher income tax brackets. This is a very large retirement account and I recommend that you enlist the help of a fee-only advisor and do some planning to minimize the overall tax bite.
Please also be aware of several important issues:
• If your father had not yet reached his “Required Beginning Date” (April 1 after the year he turned 70 ½):
a) You can take “Required Minimum Distributions” (RMDs) over your own life expectancy, but the choice and first distribution must be taken by the end of the year after the year your father died, or
b) You can distribute any amount as long as the entire account is empty by the end of the 5th year following your father’s death.
• If your father had reached his Required Beginning Date:
a) You can take Required Minimum Distributions over your own life expectancy but must take the first distribution by the end of the year after the year your father died.
b) Any Required Minimum Distribution that your father hadn’t yet taken for the year he died must be taken by you as beneficiary.
• You can always distribute more than the required minimum, just not less. Distribute less and you’ll get hit with a 50% federal penalty tax (yes, 50%!) on the amount you failed to take, plus you’ll still have to take it anyway.
• It’s often beneficial to roll an Inherited 401(k) to an Inherited IRA. Why? A broader range of investment options and more control. But be sure it’s a direct custodian-to-custodian transfer and that you don’t take possession of the funds. It’s also critical that the destination Inherited IRA be properly titled. Incorrect titling can destroy an Inherited IRA, making it fully taxable. The IRA custodian will have their preferred format.
Feel free to reach out if you have any questions or I can be of any help.