Retirement accounts fall into two basic categories: those provided by employers, and those that a person sets up on their own—which these days means Employee Sponsored 401(k) Accounts, and Individual Retirement Accounts (IRAs). Regardless of which kind they are, what happens to them after the account holder’s death is the same.
When the owner of a retirement account dies, the account can be turned over to a beneficiary. A beneficiary can be any person or entity that the owner of the account has chosen to receive the funds. If no beneficiary is designated beforehand, the estate will generally become the recipient of the account.
Taking control of an IRA or 401(k) after a loved one dies is easy. Simply present the original death certificate to the bank or financial institution where the account is held, and if you are named as the beneficiary, the account will be turned over to you. If you are the surviving spouse, you have several options of what to do:
Roll it over into your own retirement account. All the deferred income taxes associated with the IRA or 401(k) will continue to be deferred until you make withdrawals from their account. You can also use your own life expectancy for taking required minimum distributions. You can also choose who will receive the account at the time of your death (your beneficiary).
Leave it where it is. You can choose to continue to treat the account as your deceased spouse’s account. This could be a good idea if you are younger than the age of 59½ and your spouse died well before the age of 70½ — which is the time at which they would have to have begun taking required minimum distributions (RMDs). This allows you to defer taking RMDs until the deceased spouse would have been required to do so, which could still be many years away.
The surviving spouse would be hit with a 10% tax penalty if they were to begin taking withdrawals before age 59½.
Put it into an A or B Trust. This is only an option if the deceased had already established a trust in their estate plan prior to death. In this case, income taxes will still be deferred until the surviving spouse makes a withdrawal from the account of the IRA or 401(k). As the surviving spouse, you will be required to start taking RMDs calculated over your life expectancy after the account becomes part of the trust.
If you are not the spouse, but just a standard beneficiary, you have different options and restrictions. You can:
- Cash out the account and pay taxes on the distribution.
- Take the 5-Year Rule payout option, if the account holder died before age 70 ½.
- Treat the account as an inherited IRA, which would require minimum distributions to be taken by December 31 of the year following the account owner’s death.
But what if there were no named beneficiaries at all? As mentioned above, in this case, the accounts are turned over to the estate, which means the assets would be dispersed through probate court.
As you can see, the rules for inherited retirement accounts can be quite complex. In order to prevent legal or financial problems, account beneficiaries should get reliable information from a qualified professional who is familiar with IRS regulations.
Thanks to The Balance and Debt.org for the information in this article.