Inheriting Savings From an Employer Plan

If you are the beneficiary of a workplace retirement plan account for someone who has died, your first inclination may be to withdraw the funds. You do not have to take your inheritance – and the tax hit – all at once though. You have other options that could help spread out the tax impact of your inheritance. It’s important that you understand all the possibilities first so you don’t make a move that would limit your options.

Taxation

If you instruct the retirement plan administrator to distribute the money directly to you, it will be included in your taxable income in the year you withdraw it (unless it’s from a designated Roth account). And, you will only receive 80% of the amount you inherited because the tax laws require plan administrators to take 20% of the total distribution amount and send it to the IRS as a prepayment of the taxes you will owe on the payout. If you want to spread out the tax liability on your inheritance, or you’d like the assets to continue growing tax-deferred for as long as possible, you may want to consider rolling over your inherited plan assets to an IRA.

The portability options available to you depend on whether you were married to the plan participant at the time of death.

If you are a nonspouse beneficiary…

If you were not married to the plan participant, you have only one option for rolling inherited plan assets out of the plan and into an IRA. The rollover must go directly from the plan to a beneficiary IRA – sometimes called an “Inherited IRA.” When the assets are moved directly from the plan to the IRA custodian, there is no immediate taxation and no income tax withholding.

Once your inherited plan assets are in the Inherited IRA, you must take at least minimum annual payments to deplete the account within a certain number of years. (Please see our blog “IRA Beneficiary Options: For Nonspouse Beneficiaries” for an explanation of payout options.) In some cases, the payout period will be longer in an inherited IRA than it would be if you took distributions directly from an employer-sponsored retirement plan. Some retirement plans require that you deplete the account within five years. If you roll over the assets to an Inherited IRA by the end of the year following the year of the participant’s death, you will be allowed to take annual life expectancy payments. If the rollover occurs after that deadline, you will be required to distribute the assets from the plan or the IRA within five years following the year of death.

Inherited IRA

The IRA that receives a beneficiary rollover is referred to as a beneficiary IRA or an Inherited IRA. Both the deceased plan participant and beneficiary must be identified in the title of the Inherited IRA (e.g., Jane Smith as beneficiary of John Smith). You may only fund this IRA with retirement savings you inherit from this one plan participant. You cannot make any other contributions to this Inherited IRA.

If you are a spouse beneficiary…

If you were married to the plan participant, you have many more options. You may move your inherited plan assets to your own IRA or to your current employer’s retirement plan. By doing this, you will be assuming the assets as your own, and all distribution requirements under the tax laws will apply to you as if the assets were your own savings. This includes the 10% early distribution tax if you are younger than age 59½. Payments made to beneficiaries are exempt from the additional 10% tax but once you move the assets to your own IRA or retirement plan, the exemption will no longer be available to you. If you want to retain the beneficiary status of your inherited plan assets (and avoid the 10% early distribution tax), you can roll over the assets to an Inherited IRA. Once in the Inherited IRA, you must follow the IRA beneficiary distribution rules based on the plan participant’s age at death. (Please see our “Spouse IRA Beneficiaries: Understand All Your Options” blog for an explanation of payout options.)

You may move the assets to an IRA or another plan via a direct rollover, or through a distribution payable to yourself that you roll over within 60 days. Remember, however, that a distribution payable directly to you will be 80% of the total amount and the plan will send 20% to the IRS. You will owe tax on 100% of the distribution if you do not ultimately roll over 100% of the total amount to an IRA or retirement plan.

Next Steps

If you want to roll over inherited plan assets to STRATA Trust, you can go to our Forms section to open a Beneficiary IRA using our Online Account Opening feature or download the IRA account forms.

If you have questions about your beneficiary payment options, please contact us at 866-928-9394 or Service@StrataTrust.com.

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