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Author: FoolYap Big funky green star, 20000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 60051  
Subject: Inheriting a 401K Date: 2/8/2007 9:48 AM
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DW and I have a long commute, and use it to yak about all kinds of things.

This morning at one point we were talking about investing, and tax-deferred accounts, and I wondered out loud: What happens to a 401K account when you die? Does the beneficiary (in our case, each other) have to take the money out (at which point it presumably becomes taxable), or can they leave it in the plan, or roll it into their own 401K?

According to this site, it depends, but here's the part that seems to answer our (DW and mine) particular concerns:

http://www.401khelpcenter.com/mpower/feature_2beneficiary.html

The Most Likely Scenario: A Lump Sum Distribution

The most likely scenario is that you will need to take the money out of the account in one fell swoop - a lump sum distribution. "Most plans will decide automatically to kick out the money," says Cindy McCabe, Senior Manager in Employee Benefits Tax Services at Deloitte and Touche in San Francisco. "They do this for administrative reasons," so they don't have to use resources to keep track of the account of an employee who is no longer there.

The lump sum you receive will be subject to local, state and federal income tax. However, you will not have to pay the 10% early withdrawal tax even if you and/or the deceased person are under 59 ½ (the age at which account holders are allowed to start withdrawing money from their accounts without a penalty).

If you are the spouse, you are allowed to roll the money over into an IRA. This way, you can avoid paying taxes until you make withdrawals from your IRA. You should consider a direct rollover - asking the plan sponsor (employer) to transfer the money directly to the financial institution that houses your IRA. If you receive the check yourself, things become more complicated - the employer will have to withhold 20% for the IRS, and you will have to remember to deposit the check in your IRA within 60 days, otherwise the whole amount will be taxed.

If the plan contains company stock, you should check with a tax professional on possible strategies for reducing taxes when cashing it out.


So, sounds like as far as a spouse is concerned, the rules for an inherited 401K are much like the rules for leaving an employer and wanting (or needing) to exit the employer's plan.

Yet another reason to be in favor of gay marriage, so that no one should be forced to pay taxes unfairly on an inherited 401K. </RELE social comment>

--FY
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