Strategy: Don’t do anything until next year. Then, roll over the plan funds into an IRA. That enables you to stretch out payments over several years … maybe even decades.
It’s all due to a king-size tax break in the new Pension Protection Act of 2006. The new law allows non-spouse beneficiaries to use the same IRA-rollover techniques that — until now —were reserved only for spouses.
The new provision takes effect for distributions received after 2006. So, if you’ve recently inherited assets from a relative’s plan, hold on just a few months longer.
Here’s the whole story: When a participant in a 401(k) or other qualified retirement plan dies, the plan may require the account assets to be distributed to the designated beneficiaries in a lump sum, usually within five years. A spousal beneficiary can take the distribution or elect to roll it over into his or her IRA, which provides a deferral on paying tax on the 401(k) payout.
Until now, non-spouse beneficiaries couldn’t roll over funds into an IRA. Instead, they had to take a distribution under the plan’s terms, which often resulted in a big tax hit.
In contrast, with an inherited IRA, a non-spouse beneficiary must take distributions according to the required minimum distribution (RMD) rules. The exact method depends on whether or not distributions have begun (i.e., if the participant has reached age 701/2).
If distributions have started, the remaining IRA assets must be distributed at least as rapidly as the distribution method being used at the time of death.
If distributions haven’t yet started, all IRA assets must be distributed within five years of death or over the beneficiary’s life expectancy, beginning in the year after the plan-holder’s death.
New law to the rescue: The new pension law permits a nonspouse beneficiary to roll over the assets of an eligible retirement plan to an IRA. From that point on, the rules for RMDs from inherited IRAs apply. So, a beneficiary may choose to spread the tax payments over his or her life expectancy. The distribution isn’t subject to immediate tax as a lump sum.
Using the life-expectancy method also enables you to benefit from continued earnings within the IRA over time.
The rollover must be done with a direct trustee-to-trustee transfer into the rollover IRA. If the check from the retirement plan is made out to the beneficiary, the rollover privilege does not apply. Warning: Don’t commingle the inherited assets with any existing IRA assets. If you do that, you’ll lose the benefit of stretching out the payments.
- Small Business Tax Deduction Strategies No matches