Inheritance Tax for 401(k)s

Chris Bibey
by Chris Bibey

 

If you have recently inherited a 401(k) or are set to do so in the future, there are some inheritance tax implications that you should be aware of. Inheritance tax is not something that you should take lightly. The more you learn about inheritance tax the better off you will be ― especially when it comes to inheriting a 401(k).

When a person passes on, his 401(k) becomes part of his estate. That being said, the beneficiary usually does not have to wait to receive access to the balance. The beneficiary is required to pay income tax on the amount received, as well as any required estate or inheritance tax.

Whether or not you owe inheritance tax is based on many factors including where you live, as well as your relationship with the deceased. Some states do not charge an inheritance tax. Others have a graduated system in which direct relatives do not owe as much as friends or distant relatives.

All 401(k)s are the same, right? While many people believe this to be the case, nothing could be further from the truth. When considering your inheritance tax options as a beneficiary, you must realize that each 401(k) has its own rules. The IRS has the right to set basic limits, but the plan itself can be more restrictive. For instance, the IRS may not have any issue with you leaving the funds in the 401(k) plan and not paying inheritance tax on it. But plan rules and regulations may state that you have to withdrawal the money within a certain period of time. Of course, this will affect your inheritance tax situation.

If you inherit a 401(k) you should immediately request a plan description to determine the rules that must be followed. Along with this, get the help of a tax professional. He can assist you in deciphering the plan guidelines, while also helping you save as much as possible on inheritance tax among many other types.

Most people find that they are required to withdrawal the money in one lump sum. This helps the company stay organized from an administrative point of view. In this case you will owe taxes on the money, but will not be charged an early withdrawal penalty ― regardless of your age.

Now that you know more about inheritance tax and 401(k)s you should have a better idea of the steps to take if you are the beneficiary of this type of account.