Most of my clients have a 401(k), an IRA or a pension; therefore, I always
account for such accounts when I’m helping them create a sound estate
plan. If you have one or more retirement accounts, surly you want to know
if your beneficiaries will have to pay taxes on them. Read on as I answer
1. Do beneficiaries pay taxes on inherited retirement accounts?
Most of the time, yes. Other assets, such as real estate, automobiles,
life insurance and other non-retirement accounts are not considered “taxable
income” when they’re inherited. However, retirement accounts
are considered as income of the decedent. If income is withdrawn from
a non-Roth account, the beneficiary will be taxed at his or her normal
income tax rate.
2. Are all retirement accounts created equal?
No, they are not created equal, nor are they treated the same. For example,
if a beneficiary inherits a 401(k) plan, he or she will likely be subject
to more limitations than beneficiaries who receive IRAs. Also, beneficiaries
are required to withdraw funds from employer-sponsored plans within five
years of the decedent’s passing, even if the beneficiary doesn’t
want to. Beneficiary withdrawals are counted as taxable income.
In contrast, IRAS are more flexible. If the beneficiary wants, he or she
can stretch it out over their life; this allows tax-deferred growth and
it reduces their immediate tax liability. However, most employer-sponsored
401(k) plans actually require that the funds be put into an IRA when the
owner of the account passes away. Thus, those accounts can be “stretched
3. Who should I choose to be my beneficiary?
Most of the time people designate their husband or wife as the primary
beneficiary and they name their children as contingent beneficiaries. This allows
the accounts to pass outside of
probate, but it does not protect the funds in these accounts. While making beneficiary
designations for retirement accounts, make sure they align with your overall
estate planning goals. The alternative? It may make more sense for you to leave your retirement
accounts to a
trust, which can allow for ongoing benefits to your beneficiaries instead of
distributing a lump sum upon your death.
Looking for a Nashville estate planning and probate attorney?
Contact me today.