IRA and 401k Inherited Retirement Accounts

IRA and 401k Inherited Retirement Accounts

There are many types of inherited retirement accounts. Two common accounts are an IRA and a 401k. Before we get started, if you are unsure of how an IRA or 40k plan works, read our previous blog, Understanding IRA and 401k Retirement Plans.

IRA Inheritance:

An inherited IRA is an individual retirement plan that you inherit following the death of the owner. An heir will have to move assets to a newly opened IRA in his/her name. Hence the name, a beneficiary IRA. The tax treatment of the Inherited IRA remains the same as the original IRA. Rules for withdrawal have distinct differences, depending on whether the person is the deceased owner’s spouse or a non-spouse beneficiary.

If the person who inherited the IRA is a spouse (married at the time of death), and is the only beneficiary on account, he/she may treat the IRA as their own or roll it over to their own retirement account or treat themselves as the beneficiary of the account.

If the person who inherited the IRA is a non-spouse, IRS may require them to start taking required minimum distributions and pay income taxes on the withdrawn amounts. Pursuant to the Secure Act, these distributions must be completed within 10 years following the death of the account owner, starting with an inheritance after January 1, 2020. Also, as a non-spouse, there is no option to roll the assets into your own IRA.

401k Inheritance:

Much like the IRA above, when a beneficiary inherits a 401(k)-retirement account, distributions generally follow the same tax treatment as would apply to the original owner. Since the 401(k) is usually a tax-deferred account, meaning contributions to it are pre-tax, distributions to a beneficiary, when the account owner dies, could potentially result in taxes.

Taxability of withdrawals and the options available to avoid paying tax as soon as the 401(k) is inherited, depends on who the account owner named as a beneficiary, the account owner’s age at death, when the account owner died, beneficiary’s age in relation to account owner’s death and so on.

Inherited 401(k) distribution options:

  1. to take a lump-sum distribution and pay taxes in that year (available to spouses only) or
  2. roll over the money into their own retirement account or to an inherited IRA account and allow it to grow tax-free or
  3. utilize the 5- and 10-year rules- everything can be withdrawn by the end of 5th year following account owner’s death if account owner died in 2020 or earlier and 10-year rule applies if owner died in 2021 or later. Also, the 5-year rule may not be an option if the account owner was already taking RMD’s (required minimum distribution) before they died or
  4. spread the withdrawals over the beneficiary’s lifetime by taking annual required minimum distributions (which applies to eligible beneficiaries if account owner died in 2021 or later).

Contact Us

If you have any questions regarding IRAs and 401ks or for a detailed discussion, please reach out to your accountant or contact us at 203-489-0612 or fill out our contact form.

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2022-10-10T14:17:48+00:00February 23rd, 2022|Individual, IRAs & 401ks|

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