401(k) plan nonspouse beneficiaries get a tax break
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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 bad idea
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 the new

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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 workers).

The proper way to do a nonspousal retirement-plan transaction:

• Do a trustee-to-trustee transfer, not a rollover, to a properly titled "inherited IRA." • The deceased IRA owner's name must appear on the account. • The titling would look like this: Sylvester Jones IRA deceased (date of death) FBO (for the benefit of) Clarence Jones. • The check cannot be made out to Clarence directly. • The check cannot go into Clarence's existing IRA. • If the 401(k) plan administrator doesn't want to handle the trustee-to-trustee transfer, make sure the check is issued to the inherited IRA that's titled properly, as described above. • Beginning in the year following death, the beneficiary must take the minimum required distribution (or a higher amount as needed). • Funds build up in the tax-deferred account, and payments may last over the lifetime of the beneficiary.