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What To do with Inherited 401k From Parents?
In this article, I’ll explain how to protect yourself against losing your inherited 401k from parents, even if your parents passed away unexpectedly. I’ll also tell you how to maximize the value of your inherited funds and ensure that you get as much as possible.
Parents sometimes pass away before they retire, leaving behind a nest egg worth a lot of money. But if you inherit a parent’s retirement account, you may not get any of that money. This is why you should always plan ahead and ensure you receive your inheritance.
You Have Ten Years to Take the Money from an Inherited 401k
It’s never too early to start planning for retirement. But if you wait until after you turn 59 ½ to start taking distributions from your inherited 401k, you could miss out on thousands of dollars.
For example, let’s say you inherit $100,000 from your parents. At age 59 ½, you can withdraw $10,000 tax-free each year. So, if you retire at 65, you’d end up withdrawing over $50,000. But if you wait another ten years, you’ll be able to withdraw just $5,000.
This is why it’s critical to start taking distributions from an inherited 401k now. Even if you plan to continue working into retirement, you still have plenty of time to save for your future. And since you can withdraw funds tax-free, you might as well put every penny toward building your nest egg.
Two main types of inherited 401k are traditional and Roth. With a traditional account, you pay taxes on withdrawals during your lifetime. With a Roth account, you pay no taxes on withdrawals until you reach retirement age.
But regardless of whether you choose a traditional or Roth account, you can still benefit from taking distributions from an inherited account. As long as you follow IRS rules, you can withdraw up to $2,500 annually from a traditional account and $5,000 annually from a Roth account.
So, if you haven’t started taking distributions yet, here are three reasons why you should consider doing so soon:
1. You can avoid paying taxes on your withdrawals.
2. You can build up savings faster.
3. You can invest more aggressively.
How Money from an Inherited 401k Is Taxed
An inherited 401k plan is a retirement account that allows you to receive funds from someone who passed away.
These plans are usually funded by life insurance policies, annuities, trusts, or other assets owned by the deceased person.
Inheriting a 401k plan allows you to save for retirement while avoiding taxes on the money.
There are two types of inherited 401ks: traditional and Roth. Traditional accounts allow you to withdraw contributions after death, whereas Roth accounts cannot. Withdrawals from both types of accounts are tax-free.
Traditional 401ks are typically funded with pre-tax dollars, meaning that withdrawals are subject to income taxes.
Because of this, it’s important to consider whether you’d rather pay taxes now or later. Roth accounts offer another option. Contributions to Roth accounts are invested in after-tax dollars, making them completely tax-deductible.
Investing or Reinvesting Money from an Inherited 401k
An inherited 401k is money left behind by someone who passed away. Inheriting a 401k is usually a good thing since it allows you to invest the funds into a retirement account.
But while you might be tempted to spend the money immediately, there are other options available to you. One option is to roll over the money into another type of investment account, like an IRA or brokerage account.
Another option is to put the money back into the same account, which could compound interest. Whatever you decide, make sure you talk to your financial advisor before making any decisions.
Roll the Money into Your Own Retirement Account
It’s never fun to inherit money from someone else, especially when it’s money that could potentially be used for other purposes. But there are several reasons why rolling over inherited funds into your IRA is a smart idea.
For starters, it gives you control over your financial future. When you roll over inherited funds into your own retirement accounts, you gain full ownership of the assets.
This allows you to decide exactly how much money goes towards your retirement savings and how much gets spent elsewhere.
Additionally, rolling inherited funds into an individual retirement account can save you tax dollars. With traditional IRAs, you pay taxes on withdrawals during your lifetime. But with Roth IRAs, you pay no taxes until you withdraw the money after you die.
And finally, rolling over inherited funds can give you peace of mind knowing that your money is safe. Because you own the funds outright, you don’t have to worry about losing them to creditors or thieves.
So next time you receive money from a family member, consider taking advantage of the benefits of rolling over inherited funds into a Roth IRA.
Inherited 401k Distribution Options for a Spousal Beneficiary
Rollover to your IRA
An inherited 401k distribution option is available to spouses who inherit a deceased spouse’s account. When someone dies, the surviving spouse inherits assets including retirement accounts.
These accounts usually contain money contributed during the couple’s working years together. Spouses who inherit these funds can choose to roll over the money into an individual retirement account (IRA).
There are two types of IRAs: traditional and Roth. Traditional IRAs allow individuals to contribute pre-tax dollars while Roth IRAs let individuals contribute after-tax dollars.
To qualify for an inherited IRA, the beneficiary needs to meet certain requirements. First, he or she must be married to the decedent for at least ten years.
Second, the beneficiary must be age 59½ or older at the end of the calendar year following the death of the decedent.
Third, the beneficiary cannot be receiving benefits under Social Security. Finally, the beneficiary must complete IRS Form 8888 within 60 days of the decedent’s death.
After meeting these criteria, the beneficiary can elect to receive his or her share of the account as either a lump sum payment or as monthly payments.
Lump sums are paid immediately upon receipt, whereas monthly payments are distributed over a period of time.
For example, if the beneficiary receives $50,000 in a lump sum, he or she would pay taxes on the entire amount.
However, if the beneficiary chooses to receive $10,000 each month for five months, he or she would only owe taxes on the portion of the total payout that exceeds $5,500 ($10,000 minus 5 months of $2,500 equals $5,500).
There are several advantages to rolling over an inherited IRA. For starters, the beneficiary does not have to worry about paying tax penalties on any earnings from the account.
Additionally, the beneficiary can continue contributing to the account until he or she reaches age 70 ½. Lastly, the beneficiary can withdraw the money at any future time without incurring additional fees.
While there are pros and cons associated with inherited IRAs, the decision ultimately depends on the inheritance’s circumstances.
If the beneficiary meets the abovementioned qualifications, it might be worth considering taking advantage of this opportunity.
Rollover to inherited IRA
An inherited IRA is a type of retirement account that allows you to pass down money to your spouse after you die. Inheriting an IRA allows your spouse to invest the funds into his or her own IRA.
There are two types of inherited IRAs: traditional and Roth. Traditional IRAs allow you to contribute to the account during your lifetime while Roth IRAs require contributions to be made after you turn 59½.
Traditional IRAs are usually rolled over directly into a beneficiary’s name. In contrast, Roth IRAs are typically transferred into a beneficiary’s name via a trustee who holds the assets until the beneficiary reaches age 59½. When transferring a Roth IRA, the trustee pays taxes on the amount contributed.
To roll over a traditional IRA into a beneficiary’s name:
➢ First, open a custodial account with your bank or brokerage firm.
➢ Transfer the balance of your IRA into the custodial account.
➢ Wait until the beneficiary turns 70 ½ years old.
➢ Then, contact your financial institution to request a distribution of the funds.
Leave money in the plan
One of the biggest mistakes people who inherited 401k from parents make is leaving money in their inherited 401k.
While it’s understandable that they’d want to put their own money into retirement accounts, doing so could result in penalties and taxes.
For example, if you withdraw $10,000 from your inherited account, you’ll owe 10% federal income tax plus another 3.4% Medicare tax.
So instead of putting the money into your own IRA, consider leaving it in place until you reach age 59½. At that point, you can roll over the funds into your own IRA.
This strategy will allow you to avoid paying taxes on the distribution while still accessing the money later. Plus, since you’ll be rolling the money into your own account, you won’t face additional fees or penalties.
Inherited 401k Distribution Options for a Non-Spousal Beneficiary
Your inherited 401k plan might offer several options for distributing money to beneficiaries after your death. These options range from lump sum distributions to monthly payments over a certain number of years.
It’s important to understand the differences between each option to choose the distribution method that’s best for your situation. Here’s a quick overview of the four main options available to non-spouse beneficiaries:
1. Lump Sum Distributions: With this distribution, beneficiaries receive a single payment upon receiving the inheritance. There are no ongoing payments or taxes associated with this option.
2. Annuity Payments: With this option, beneficiaries receive periodic payments over a set period of time. Taxes are withheld from the payments during the beneficiary’s lifetime and then paid back to the beneficiary when he or she receives the final payment.
3. Immediate Payment Option: With this option, the funds are distributed immediately upon receipt. No taxes are withheld, but beneficiaries pay income tax on the amount received.
4. Life Insurance Proceeds: With this option, proceeds are placed into a life insurance policy owned by the deceased person. When the insured dies, the beneficiary receives the cash value of the policy.
Both methods require planning, but they serve very different purposes.
A will allows you to specify who gets what after your death. For example, if you own a house worth $500,000, you could write a will specifying that half of the property goes to your son and daughter while the other half goes to your wife.
However, if you die intestate (without having written a will), the state will distribute your estate according to its laws.
A trust lets you transfer assets to someone else without going through probate court. Instead, the assets are transferred directly to the trustee, who manages them until the beneficiary reaches adulthood. Once the beneficiary turns 18, the trustee distributes the assets to him or her.
While both wills and trusts allow you to designate beneficiaries, they differ in how much control you retain over the assets.
Wills give you complete control over the assets, whereas trusts give trustees broad discretion to manage the assets.
Here’s How to Avoid Costly Mistakes if You Inherit a 401k or IRA
Before you decide whether or not to accept the inheritance, you should understand exactly what you’re taking on.
There could be tax implications, penalties, and fees involved. Also, you should consider whether or not you can afford to pay back the money you receive.
To avoid making costly mistakes, here are three tips to follow:
1. Make sure you understand the terms of the inherited account.
2. Check with your financial advisor to ensure you’re eligible to withdraw funds.
3. Consider investing the money in a low-cost mutual fund instead of withdrawing it immediately.