By simply showing the original death certificate to the bank or financial institution where the account is stored, anyone can take possession of an IRA or 401(k) after a loved one passes away. Only that the person be designated as the beneficiary is necessary. The inheritance of this kind of account, however, may have tax repercussions.
Tax treatment can vary greatly depending on the beneficiary’s relationship to the deceased and whether they are An inherited IRA or 401(k) allows the surviving spouse the most flexibility in terms of what can be done with it (k).
Roll Over the Account
The option to roll over an IRA or 401(k) into the surviving spouse’s personal retirement account is available. Until the surviving spouse takes withdrawals from their account, any deferred income taxes related to the IRA or 401(k) will remain deferred.
When calculating needed minimum distributions, the surviving spouse may additionally take into account their own life expectancy (RMDs). They can designate their own beneficiary and decide who will get the money when they pass away.
Keep the account private.
The account can still be used as the deceased spouse’s account by the surviving spouse. The advantages of this choice are only applicable in the rare circumstance where the surviving spouse is under the age of 5912 and the first spouse passes away before they would have been forced to start taking required minimum distributions at the age of 701. (RMDs).
If the surviving spouse started taking withdrawals before turning age 5912, they would be subject to a 10% tax penalty.
If you turn 7012 by 2019, you must start taking RMDs at this age. The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) raises the age to 72.3 in the absence of that.
The surviving spouse can postpone taking RMDs until the time when the deceased spouse would have been obligated to do so if the account was left in its current state. After that, they are able to withdraw money from the account without paying the 10% early withdrawal penalty. When kids turn 12 years old, they can convert the account into their own retirement account.
If the surviving spouse passes away prior to turning 5912, they may designate who will receive the account.
Put money into an A or B trust.
If the trust was created in the deceased spouse’s estate plan prior to their death, the surviving spouse may also transfer the retirement account into an A or B trust. A beneficiary designated or a disclaimer by the surviving spouse can cause this.
If the IRA or 401(k) is joined to the trust of the decedent spouse, income taxes will still be postponed until the surviving spouse withdraws money from the account. After the account is incorporated into the trust, the surviving spouse will be obligated to begin taking RMDs calculated over their life expectancy.
However, if the surviving spouse passes away, the beneficiary of the account cannot be changed.
Estate Tax Repercussions
Due to the federal tax code’s unlimited marital deduction, spouses can leave assets to one another upon death without incurring estate taxes.
However, if they were to roll it over into their own account, 100% of the fair market value of the IRA or 401(k) as of the date of the surviving spouse’s death would be counted as part of their inheritance for estate tax purposes.
However, if the IRA or 401(k) was put into a B trust, the value of the account would not be counted as part of the surviving spouse’s estate.
There is an exemption to this rule if the surviving spouse marries again and names their new spouse as the account beneficiary. This time, the unlimited marital deduction would be in effect.
Except If You Are the Surviving Spouse
If you are not the surviving spouse, the decision you make regarding how to handle an inheritance from a retirement account will determine the income tax implications. You are given two choices.
Transfer the account into an inherited IRA: If you choose this option, you must start taking required minimum distributions (RMDs) by December 31 of the year after the death of the account owner. The distribution would be computed based on how long you expect to live. Additionally, you can withdraw more money as necessary. Each year that a distribution is received, the amount will be counted toward your taxable income.
Pay off the account entirely: If you select this option, the full distribution would be counted as part of your taxable income.
Estate Tax for Beneficiaries Who Are Not Spouses
If the IRA or 401(k) was bequeathed to anybody other than a surviving spouse, the whole fair market value of the account would be counted toward the deceased owner’s estate for estate tax purposes. If the combined value of all the deceased owner’s assets, including the value of the IRA or 401(k), exceeds the federal or state estate tax exemption for that year, the estate would be liable for estate taxes.
As of 2022, the federal estate tax exemption is $12.06 million, so most taxpayers might not be concerned about this. Only assets valued above this threshold are subject to estate taxation.
When the Account’s Estate Taxes Are Due
If the deceased owner’s estate is taxable and there aren’t enough assets outside the IRA or 401(k) to cover the estate tax payment, it may present problems for the beneficiary of the IRA or 401(k). However, because of the $12.06 million exemption, this only applies to highly expensive estates.
The beneficiary’s taxable income would be increased by the amount of each withdrawal from an IRA or 401(k). If the beneficiary needs to withdraw additional funds from the account to cover the estate tax payment, it will result in higher income taxes.
Unless, of course, you leave the account to your surviving spouse, in which case any estate tax burden is simply deferred rather than eliminated, and your estate has enough cash or other assets to cover the estate tax payment.
Questions and Answers (FAQs)
What would happen to my 401(k) if I passed away following a divorce?
In the event of your passing, you can name a beneficiary for your 401 (k). Your assets, including a 401(k), will be distributed to your surviving relatives in accordance with state law if you pass away without naming a beneficiary or making a will. If you are married, your spouse is your next of kin; if you are divorced, your children, grandchildren, parents, or siblings are often the recipients.
An IRA can be passed down to a child
Until they reach the age of majority, a child can inherit an IRA and start taking distributions based on their own life expectancy rather than that of the original owner (18 or 21, depending on the state). The remainder of the account after that must be distributed within ten years.