What Should I Do with an Inherited 401(k) or IRA?

Inheriting a 401(k) or IRA can be a significant financial opportunity, but it comes with complex rules and considerations. It’s essential to make informed decisions to manage this new asset effectively. You’ll want to align your decisions with your financial goals, understand the tax implications, and consider seeking guidance from a fee-only financial advisor for personalized advice related to your situation. Here are some helpful tips for what you should do if you inherit a 401(k) or IRA.

Understand the Rules and Options

Most importantly, you need to be aware of the rules governing inherited retirement accounts. The IRS has specific regulations for inherited 401(k)s and IRAs, particularly around Required Minimum Distributions (RMDs). These rules differ based on whether the original account holder was your spouse or another relative (non-spouse).

Spouse Beneficiaries

Spouses who inherit an IRA have the most flexibility. They can:

• Transfer the funds to their own IRA and follow the standard rules for their age and situation.
• Begin taking Required Minimum Distributions (RMDs) based on their own age if they transfer it to their own IRA, or based on the decedent’s age if they keep it as an inherited IRA.

Non-Spouse Beneficiaries (under the SECURE Act):

For IRAs inherited from account holders who passed away after 2019, most non-spouse beneficiaries are required to withdraw all assets from the inherited IRA within 10 years of the account holder’s death. This is a significant change from the previous rule that allowed beneficiaries to stretch withdrawals over their lifetime (known as the “stretch IRA” provision).

• The 10-Year Rule: Beneficiaries are not required to take a distribution each year, but all funds must be withdrawn by the end of the 10th year following the year of inheritance.
• Exceptions: Certain eligible designated beneficiaries are exempt from the 10-year rule and can still use the lifetime stretch option. These include minor children of the original account holder (until they reach the age of majority), disabled individuals, chronically ill individuals, and beneficiaries not more than 10 years younger than the account holder.

Tax Implications

Withdrawals from a traditional inherited IRA are typically subject to income tax, as the distributions are considered taxable income. However, Roth IRAs, while still subject to the 10-year rule, generally offer tax-free distributions since the original contributions were made with after-tax dollars.

No Early Withdrawal Penalty

Beneficiaries of IRAs are not subject to the 10% early withdrawal penalty, regardless of their age when they take distributions.

Consider a Rollover

For a non-spouse beneficiary, transferring the inherited 401(k) to an Inherited IRA could be beneficial. This move often provides more investment options and potentially lower fees, as well as easier access to withdraw funds. However, ensure that this rollover adheres to IRS guidelines to avoid unnecessary penalties.

Evaluate Your Financial Goals

Align your decision with your long-term financial goals. Perhaps your best investment is eliminating debt and investing newly freed up cashflow. Stay away from annuities or other financial products sold by investment advisors. Unfortunately there are many Financial Advisors in Marietta Georgia and beyond that are looking to make a healthy commission of your new inheritance. Look for advice from a fee-only, fiduciary wherever you are located.

Keep in mind that it’s important to consult with a financial advisor or tax professional for personalized advice, as the rules can be complex and are subject to change. They can provide guidance based on the specifics of your situation and any recent changes in legislation.

Have questions? Feel free to contact us.