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A reader recently asked if his 401(k)
could be rolled over, by his beneficiary, to a 'stretch' IRA after
his death. Read on to discover an answer that will protect your
beneficiaries from tens of thousands of dollars in unnecessary taxes
and keep your gift to them alive for generations to come.
Whether or not your beneficiary can rollover your 401(k) at your
death (and subsequently stretch it) depends on who your beneficiary
is and the terms associated with your company plan. Basically, you
usually can’t stretch a 401(k) account directly, but if that money
is rolled into an IRA, you can. This is a situation where the
details matter.
Let's assume for the sake of illustration that you have a wife and 3
children. If your spouse is the beneficiary, she can roll the money
from your 401(k) to her own IRA. Assuming that she has named the 3
children as beneficiaries of her IRA, they would have the ability to
stretch it at her death. (‘Stretching’ an IRA refers to the ability
for a beneficiary to take distributions based on their life
expectancy instead of all at once.)
Ideally, she would divide the money into 3 IRAs and name one child
as the beneficiary for each one. That allows each child to stretch
the IRA over their life expectancy. If the 3 children are the
beneficiaries of 1 IRA then it would be stretched based on the
oldest beneficiary’s life expectancy.
On the other hand, if your children are the beneficiaries of your
401(k) plan they may or may not be able to stretch it. Let me
explain. The tax laws allow for beneficiaries to stretch out
distributions, but most company retirement plans do not permit it.
The reason is simple--the stretch can take place over decades.
If the company allowed that, then they would be responsible for all
the administration. There isn't any benefit to the company to do so
while it exposes them to potential liability. Instead, most company
plans will cash out the beneficiaries at the death of the employee.
At best, the beneficiaries may be able to stretch it out over 5
years.
Realize what this means. Let's say you have $600,000 in your 401(k).
If your wife is the beneficiary, she can roll it to her own IRA and
then when she dies, the children can stretch it. If a child is in
their 50’s, that means that taxes can continue to be deferred
(except for the annual required distribution) for almost 30 years.
$200,000 can literally grow to millions of dollars over 30 years.
If those children were the beneficiaries of your 401(k) instead and
were cashed out at your death, they would not have the ability to
roll that money to an IRA. They would have to pay taxes on all of
that money in the year it was distributed. In our example, each of
your three children would have to claim $200,000 in ordinary income
that year! This would bump each child’s tax bracket and could result
in 35% of it being lost in taxes. That’s a tax bill of $70,000 each,
or a total of $210,000 in taxes on your $600,000 nest egg.
Even if you have your wife as the primary beneficiary of your 401(k)
and your children as the contingent beneficiaries, you are opening
up the possibility of the children not being able to stretch
distributions. If your wife passes away before you, or you both die
in an accident, the 401(k) money would go to the children and most
likely be distributed immediately.
There really aren't any benefits to keeping your retirement money in
a 401(k) after you retire, but several big disadvantages. All of
this is easily avoided by simply rolling that money to your own IRA.
Your investment options will be much greater, and so will your
flexibility and control.
I love to personally answer readers’ questions. If you’d like free,
unbiased advice submit your questions to www.guardingyourwealth.com/askjeff.htm.
Read answers to questions other readers have asked on the Q&A page
at www.guardingyourwealth.com.
Mr. Voudrie is a Certified Financial Planner, nationally syndicated
newspaper columnist and President of Legacy Planning Group, Inc., a
Private Wealth Management Firm in Johnson City, TN. He can be
reached toll-free at 1-877-827-1463 or at jeff@guardingyourwealth.com.
[For more Free Financial Advice and information about 'stretch'
IRA's read ‘How To
Stretch Your IRA - Tax Free’ and ‘Q&A:
Stretching An IRA’]
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