What happens to 401k and other retirement accounts when the "owner" passes away?

Question

When someone dies, leaving an estate to their beneficiary, it could include stocks, bonds, investment accounts, retirements, real property, etc.

I believe everything under $2 million passes to the heirs without any tax obligation. (Is this correct?)

My question is about the tax-deferred retirement accounts (non-ROTH) that collect ordinary income tax when you draw the funds. Would this tax be required from the heirs?

Thanks.

Answer 1

First, the money passes to the beneficiary outside of probate so it doesn't fall under the estate tax rules. No different than insurance proceeds. One thing to keep in mind is that the "owner" of the 401k account is not the individual (no matter what you've heard or believe this is not true). The owner of the account is the trust. The assets are held for the benefit of the individual participant; which is why it's treated like insurance proceeds.

Upon the death of the individual participant, it is taxable income but not until the money is actually withdrawn. Recent tax law changes allow both spouses and non-spouses to roll over beneficiary accounts and postpone the taxable distribution. So the taxation can be delayed. However, the life expectancy of t he original holder of the assets follows the account and it must be paid out no later than it would have been had the original holder been alive.

So, bottom line is that you can delay the tax man but you can't evade him.

Answer 2

Money in traditional IRAs, 401Ks, 403Bs, TSPs, etc. is pre-tax. Since the decedent didn't pay any taxes on them, the beneficiary will. (Even if the money is left to the estate, the estate would owe the income tax.)

If the amount in the account is modest, the beneficiary can simply take the money, add it to their income that year and pay the additional tax.

If the amount in the account is large, taking it all in one year can bump them into a higher tax bracket. The rules have been changing for IRAs (1 year vs 5 years vs lifetime), so it's best to check with an accountant before taking the money.

Answer 3

Eventually tax will have to be paid. In some cases the beneficiary can add the value of the IRA or 401k to his or her own IRA accounts. In that case, income tax will be paid when the beneficiary elects to start taking distributions. Alternatively, the beneficiary can take a distribution immediately, which would result in income tax immediately. The best course of action will depend on the individual situation.

Answer 4

Yes, for tax deferred retirement accounts that a person inherits, withdrawals are taxable income. They don't get the benefit of the $2 million exclusion.

Answer 5

My father passed away and left his IRA to my mother she is in Hospice Care our sister passed away all had Cancer she my brother and myself on her accounts to pay her bills butnot on the IRA what do we do about that money?