|401(k) plan nonspouse
beneficiaries get a tax break
And don't count on the 401(k) plan administrators to know how the money should be transferred to beneficiaries in the most tax-effective way, either. It's tricky. The only one you can really count on is yourself.
Why a lump-sum payout is a
Let's say Sylvester passes away unexpectedly and leaves 50 percent
of his 401(k) plan to his wife, Thelma, and 50 percent
to his son, Clarence, age 23. (The account is worth $1 million.
Thelma and Clarence don't do anything immediately. They wait until
law takes effect in 2007. Then Thelma, a sensible woman, rolls over
her portion of the assets into her existing IRA account. Clarence,
wanting to impress his mother, does the same.
Uh-oh. Clarence made a mistake: He can't directly
roll over the funds, he discovers. Too late. He will have to recognize
$500,000 as income in 2007. Though he makes a modest annual salary
of $35,000 as a teacher, he suddenly finds himself in the 35-percent
tax bracket. He owes roughly $187,000 in taxes for the year, not
including state income taxes, if any. And after indulging $100,000
in a 2007 Porsche 911 Carrera two-door convertible, he's whittled
the funds down to just over $200,000. After all, now that the money's
so handy in the ole' bank account, he finds it extremely easy to
satisfy his whims.
OK, even if he doesn't get the car, he's still down almost 200 grand -- a huge cut for Uncle Sam. And then any future earnings are subject to taxation.
The alternative scenario: If Clarence transfers the assets into a properly titled inherited IRA, he could limit his first withdrawal amount at age 24 to $8,460. His account balance of $491,540 could continue to grow in the tax-deferred vehicle, thereby allowing him to take distributions over his lifetime. He would not owe tens of thousands of dollars in taxes.
These same benefits are already in place for nonspousal beneficiaries
of IRA plans. But the beneficiaries must follow the same procedures
to get the tax break.
How to claim the inheritance
Nonspousal beneficiaries of 401(k) plans must follow
the steps outlined below or suffer severe consequences. By the way,
this change in the law also pertains to profit sharing plans, 403(b)
plans (for teachers and nonprofits) and 457 plans (for government
||The proper way to do a nonspousal retirement-plan