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Inherited 401k?

3,475 Views | 23 Replies | Last: 9 mo ago by Horse with No Name
Leander - Ag
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5:28p, 2/5/24
AG
My wife has inherited her parents 401k. I assume the only way to avoid taxes is to roll it into our 401k / IRA?

If you cash out you pay at your current tax rate?

Thanks
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Casey TableTennis
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6:39p, 2/5/24
AG
Only a spouse can transfer to their IRA when inheriting so y'all won't be able to roll into your IRA. Can be rolled/transferred into a beneficiary IRA to avoid tax hit up front.

It is possible the 401(k) has other buckets like Roth, after-tax or other less common ones. It gets a little more complicated if anything other than all-pretax exists, but is still easy enough to manage through.
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Superfreak
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6:42p, 2/5/24
AG
I believe she can roll it over to an inherited IRA in her name. Since this is a non spouse relationship she will likely be required to take RMD and empty the account in 10 years. There are some exceptions I believe. I don't think you can (or want to) roll it into an IRA you wife already has.
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Waterski02
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10:03p, 2/5/24
AG
It's been a bit and some things have changed, but it should roll into an Inherited IRA and you used to have the choice to liquidate in X number of years or take RMDs, both of which are taxed as income. Depending on her age the annual RMD hit isn't that bad, my mother's estate gives me a roughly 3k RMD after 12 years, I roll that directly into my Roth IRA. Relatively straight forward process, just don't forget to take your RMD, cause the penalty stings.
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tamcmsh
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10:20p, 2/5/24
AG
Rules changed a few years back. You can't roll and comingle with an existing account. You have to take RMD's over a 10 year period so the IRS can take their tax bite.
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permabull
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In reply to Waterski02 • 7:50a, 2/6/24
AG
You inherited it before the secure act passed and chose to stretch the IRA. Now when you inherit a tax deferred account you have to liquidate it withen 10 years and pay income tax while it comes out. There are a few exceptions (i.e. if the beneficiary is disabled or less than 10 years younger than deceased)
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Horse with No Name
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10:02a, 2/6/24
Assuming your wife's parents died after Secure Act passed in 2019...

You have 10 years to take funds out in their entirety. It doesn't matter if you take them all in one year or spread over 10, they have to be liquidated within 10 years.

As said above, unless the 401k had Roth component, liquidated funds will be taxable as ordinary income. As a general rule of thumb, funds in Roth accounts can be invested for the full ten years, then liquidated tax free at max accumulation. Non-Roth funds can only be managed out to "fill up" your current tax bracket. Keep in mind that tax rates go up in 2026, so it may be advantageous to take funds over next two years.

There is likely a mandatory withholding of 20% from inherited 401k, thus the reason for rolling into an inherited IRA.

There was never an option for a non-spouse to roll into an IRA owned by said non-spouse, but you can match your distributions up with contributions each year to minimize tax impact. For example, take out $7000 from inherited account (taxable) make contribution to tax-deductible IRA. This can be done for both spouses to maximize impact, but you must have EARNED income equal to or exceeding the amount of IRA contributions, i.e. you can't be already retired for this to work.

Any further advice would be worthless without knowing your current income/income sources, current tax bracket, age, size of the inherited account, etc. You didn't mention it specifically, but FAFSA considerations if you have college age, or near college age children, are huge. There are a few strategies to be implemented, but those are limited after the death of the account owner.
Ridin' 'cross the desert. . .
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Leander - Ag
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1:19p, 2/10/24
AG
Thanks for help. I do have a kid currently at A&M
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Yukon Cornelius
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6:02p, 2/10/24
AG
Why don't you just cash it out and pay the taxes and invest it in something else?
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Leander - Ag
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In reply to Yukon Cornelius • 2:21p, 2/11/24
AG
Yukon Cornelius said:
Why don't you just cash it out and pay the taxes and invest it in something else?


Sounds like that's the only option so plan to
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OldArmyCT
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In reply to Yukon Cornelius • 4:26a, 2/12/24
AG
Yukon Cornelius said:
Why don't you just cash it out and pay the taxes and invest it in something else?
Depending the size of the inherited IRA that could be a huge tax hit. Like, big.
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DannyDuberstein
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In reply to OldArmyCT • 8:18a, 2/12/24
AG
OldArmyCT said:
Yukon Cornelius said:
Why don't you just cash it out and pay the taxes and invest it in something else?
Depending the size of the inherited IRA that could be a huge tax hit. Like, big.


This. Start with getting it moved to an inherited IRA and then spend some time determining the most tax advantageous timing over the next 10 years to withdraw it. If it is a sizable amount most likely answer is going to be to spread it out into 10 chunks (not necessarily all equal) to keep it from sending you into higher tax brackets than necessary.

I'd take your projected annual income for the next decade without it, note where the next tax bracket tiers are and how much room you have before hitting the next 1-2, and then see how much makes sense to take.

Using myself as an example, I just inherited a sizable IRA in the past year but I plan to retire in 5-6 years. So I plan to wait and lean into those last 4-5 years when my own income drops off.
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Yukon Cornelius
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In reply to OldArmyCT • 11:59a, 2/12/24
AG
But wouldn't you just pay the tax out of the gains and use the rest to reinvest? Feels like always locking your cash up for fear of the tax man is a bit of a mental scam played on people.
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DannyDuberstein
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In reply to Yukon Cornelius • 12:38p, 2/12/24
AG
He will owe tax on 100% of the distribution as ordinary income, not the gains. He can invest it how he wants as long as it is in the IRA. Let's say he and his wife make $250k per year and the inherited 401k is $500k. Take it all in one year and he's reporting $750k in income. Take it in 5 $100k chunks and what they take out can keep it in the 24% bracket. Take it all in one year and they are going to pay an extra 8-13% on $400k of the $500k in tax to Uncle Sam. I don't know about you, but if I can avoid paying $40-50k+ to Uncle Sam that I don't have to, I will.

Then again, if it's only $100k, maybe you decide to take it all, have it hit for the 24% rate, and move on. Really all depends on their income, the size of the 401k, and where that combo sits vs the brackets.


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htxag09
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In reply to DannyDuberstein • 1:57p, 2/12/24
AG
But aren't tax rates supposed to increase in a couple of years? And who knows beyond then....
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Yukon Cornelius
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In reply to DannyDuberstein • 1:59p, 2/12/24
AG
That makes sense. Assuming they are already in the highest bracket it wouldn't benefit to wait correct? Also you don't get any bias of what her father put in?
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Foamcows
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2:44p, 2/12/24
AG
or they file taxes separately, she takes a 1 year leave (or just quits) for her current job, then takes the full distribution in that gap year, and moves on from there...
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DannyDuberstein
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In reply to Yukon Cornelius • 2:50p, 2/12/24
AG
Yukon Cornelius said:
That makes sense. Assuming they are already in the highest bracket it wouldn't benefit to wait correct? Also you don't get any bias of what her father put in?


Yes, if making $700k+ without it, then it wouldn't necessarily matter. I didn't peg someone asking this board for 401k/tax advice to likely be in that category.

Taxes have never been paid on what is sitting in a traditional 401k, so whether it's your 401k or an inherited, 100% of it is getting taxed when you take distributions. That's why the govt has the RMD regulations, to make sure they get to take their bite
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DannyDuberstein
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In reply to htxag09 • 2:55p, 2/12/24
AG
htxag09 said:
But aren't tax rates supposed to increase in a couple of years? And who knows beyond then....


Correct. I tend to think the existing will get extended, but many unknowns ahead. I would just say that in general, if it's a larger amount, taking it all at once likely results in the most unfavorable outcome.
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htxag09
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In reply to DannyDuberstein • 2:58p, 2/12/24
AG
DannyDuberstein said:
htxag09 said:
But aren't tax rates supposed to increase in a couple of years? And who knows beyond then....


Correct. I tend to think the existing will get extended, but many unknowns ahead. I would just say that in general, if it's a larger amount, taking it all at once likely results in the most unfavorable outcome.
Probably a dumb question, but I've never delt with anything like this so learning from this thread.

But...say you ended up making $150k as a family in 2023 so you wanted to withdraw money from that inherited 401k since you were in the 22% bracket. Do you have to do that in 2023 or do you have grace that extends to 2024, so you could wait and get your W2s before making that decision?
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DannyDuberstein
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In reply to htxag09 • 3:00p, 2/12/24
AG
Pretty sure it has to be done by 12/31. Unlike being able to contribute to an IRA late, 12/31 seems to be the hard rule on distributions.
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Yukon Cornelius
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In reply to DannyDuberstein • 3:08p, 2/12/24
AG
Makes sense, thank you
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Horse with No Name
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In reply to htxag09 • 10:01a, 2/13/24
htxag09 said:
DannyDuberstein said:
htxag09 said:
But aren't tax rates supposed to increase in a couple of years? And who knows beyond then....


Correct. I tend to think the existing will get extended, but many unknowns ahead. I would just say that in general, if it's a larger amount, taking it all at once likely results in the most unfavorable outcome.
Probably a dumb question, but I've never delt with anything like this so learning from this thread.

But...say you ended up making $150k as a family in 2023 so you wanted to withdraw money from that inherited 401k since you were in the 22% bracket. Do you have to do that in 2023 or do you have grace that extends to 2024, so you could wait and get your W2s before making that decision?
Assuming the original owner died in 2023, the beneficiary has 10 years from date of death to liquidate the account in any fashion--equal installments, lump sum, whatever. As Danny has pointed out, tax brackets and amount of the 401k make all the difference.

As for 2023, distributions for that tax year closed at the close of business on 12/29/2023. I do not know of a way in which distributions are counted any other way than calendar year. This is confusing because IRS does allow contributions all the way up to tax filing deadline. So, no, you would have to make your best guess as to your final income to max out the 22% bracket. Fortunately, as long as you're not making medicare premiums or receiving other benefits that are income dependent, the worst that will happen is falling a bit short of the 22% max or a few $$ being taxed at 24%.

On the other hand, medicare recipients can screw themselves into higher Part B premiums for a year or more by overshooting on income.

Ridin' 'cross the desert. . .
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Horse with No Name
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In reply to DannyDuberstein • 10:03a, 2/13/24
DannyDuberstein said:
htxag09 said:
But aren't tax rates supposed to increase in a couple of years? And who knows beyond then....


Correct. I tend to think the existing will get extended, but many unknowns ahead. I would just say that in general, if it's a larger amount, taking it all at once likely results in the most unfavorable outcome.
I'm not as optimistic as you. I think there's too much inertia in congress to do nothing, and I don't think either party winning the election results in that changing.
Ridin' 'cross the desert. . .
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