The death of a loved one is stressful, and settling final arrangements, including finances, can only make it harder. But knowing how to handle the complex rules for retirement accounts can help lessen the burden.
The rules for inherited IRA and 401(k) retirement accounts can be complex. The first thing you should do if you’re a beneficiary is stop and take a deep breath.
“Complex rules often confuse and frustrate beneficiaries, so sometimes they take the lump sum because it seems to be the easiest solution,” said Lori Rodgers, a senior wealth strategist with PNC Wealth Management®.
“Depending on your financial situation and goals, that could be a mistake, so you need to understand your options,” she said.
“Resist the urge to cash in the complete account if you inherit a retirement account. The tax bite might be large because inherited retirement accounts are taxed at the same rate as ordinary income such as wages,” Rodgers said. “In addition, by not taking the lump sum, the account has the potential to continue to grow on a tax-deferred basis. Over time, this can be a nice complement to your own retirement savings.”
It’s also important to consider your own retirement accounts and how this inherited asset fits into your goals and plan.
Different Relationships, Different Rules
If you’re a beneficiary, you need to be aware that there are different rules if the IRA and/or 401(k) plan is coming from your spouse or if it is from another individual such as a parent, a sibling or any other person.
If you inherit a retirement account from your spouse, it’s generally very simple: you can roll that asset into your own IRA and manage and invest it as you would your own retirement account; no distributions are required until you turn age 70 1/2, Rodgers says. But if the account comes from someone other than a spouse, the process can be far more complex.
If you inherit an account under these circumstances, you generally must put the funds into a designated inherited IRA and take required minimum distributions annually based on your life expectancy as determined by IRS-provided tables. Those distributions must begin by December 31, in the year following the death of the owner of the account, Rodgers said.
Plan Early, Communicate Often
Most important, as with any estate planning issue, communication is crucial. Work with the appropriate professionals to decide where assets will go after your death, and be sure all beneficiaries are aware of your plans.
“It is critical that retirement account owners keep beneficiaries up-to-date on IRAs or 401(k) plans so that the transfers are smooth,” she said “We recommend that retirement account owners review their entire estate plan at least once a year. A good time to do that is around open enrollment time at your place of employment,” she said.
Rodgers also says those who inherit a retirement account should then make sure they name the beneficiaries of their own accounts for when they die.
While estate planning can be complicated, preparing with a professional advising team can help ease the burden, making a stressful time a little more bearable.
Lori Rodgers is a senior wealth planner at PNC Wealth Management
“Sometimes dealing with complex rules for inherited retirement accounts can make beneficiaries throw their hands up in frustration.” –