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What to do with a Big 401(k) Inheritance

What to do with a Big 401(k) Inheritance

If you’ve recently inherited a hefty 401 (k), be careful. Look into all your options before taking any action. Otherwise, too much of it could go to Uncle Sam.

Consider these choices:

  1. Doing nothing and leaving the account in place. This may be the simplest option, but it’s not necessarily the best one. For starters, this option may not even be available. Find out from the deceased’s employer what the rules are regarding distribution of the funds. You may be required to take it all out in a lump sum within one to five years.

If you are allowed to keep the plan in place, you will be required to withdraw the required minimum distribution (RMDs) each year based on the deceased’s original life expectancy. That’s fine if the original owner was younger than you. If not, you will be forced to withdraw funds and pay taxes on them, before you want or need them. That added income may also suddenly bump you into a higher tax bracket, increasing your tax obligation significantly.  You won’t be able to designate your own beneficiaries either. Instead, if you die, the remaining funds would go to your estate.

  1. Transfer the funds into your own IRA. If you are not yet 70.5, this option allows you to delay having to take the RMD each year as required by law. No RMDs also means no additional taxes too. And more time for the funds to grow. This applies to traditional IRAs only as those are tax-deferred. This does not apply to Roth IRAs as those funds come from taxed income. Also, keep in mind that if you are under 59.5, you won’t be able to touch any funds from your traditional IRA without incurring a 10% early withdrawal penalty. If you think you will need the funds in the near future, this may not be an ideal option.
  2. Roll the funds into an inherited IRA. If you are not the spouse of the original account holder, this may be a feasible option. While you will still have to pay income taxes whenever you withdraw funds, you do not incur any penalty regardless of your age. Instead, you can: take the entire amount out in one lump sum, over five years, or take RMDs based on your own life expectancy. Unless you need the funds urgently, this last option preserves the funds the longest for growth while helping you spread out the taxes over many years.

When you inherit a sizeable 401 (k), meet with a tax attorney and your financial planner to determine the best option before making any decisions. Doing so can mean more money to you and less to the government.

At Silverman Financial, our experts can help you decide what to do with an inheritance. We create comprehensive financial roadmaps to make sure your funds last throughout your entire retirement.