Jason York | Getty Images
So you get a retirement account.
Before you decide on when and how to access money, you should familiarize yourself with the rules that apply to various beneficiaries. The rules for these retirement plans can be complex. Therefore, errors can occur and, depending on the specific nature, can be difficult to undo.
Due to the Safety Act of 2019, your options to manage an inherited 401 (k) plan or personal retirement account depend largely on your relationship with the deceased. The law cuts the ability of many beneficiaries to extend their own lifetime distributions if the original account holder dies on January 1, 2020 or later.
More from personal finance:
How is social security benefit handled upon death?
Avoid these mistakes when rotating a 401 (k) to an IRA.
Here are some money mistakes to avoid in divorce.
Unless you have exceptions – you are the holder’s spouse or underage child, for example, those inherited accounts typically expire within 10 years.
This is something you should know.
Not a flexible spouse
If the beneficiary is the underage child of the deceased, the 10-year loss rule will begin when they reach the age of majority in which they live. In most states, 18 years old.
Before getting to that point, the child will need to take the required minimum annual distribution, or RMD, as known, based on his or her life expectancy. (Typically, these required withdrawals begin for retirement assistants at the age of 72 – or 70o if they are before 2020 – in accordance with the account holder’s expected service life.)
“So if you have 10-year-olds taking RMDs, they’ll do so until they turn 18 when they switch to the 10-year rule,” said Brian Ellenbecker, a Shakespeare Wealth Management Certified Financial Planner in Pewaukee. Wisconsin
In addition, beneficiaries who are chronically ill or disabled or those younger than the deceased up to 10 years can receive distribution based on their own life expectancy and not subject to the 10-year rule.
All other beneficiaries who are not spouses.
If you are a beneficiary under the 10-year termination rule because you did not pass the exception, it is important to consider how you will meet that requirement.
“There is no amount of money you have to spend each year. But they have to be withdrawn within 10 years, ”said CFP Peggy Sherman, principal advisor to Briaud Financial Advisors in College Station, Texas.
The process generally involves setting up an inherited IRA and transferring the money to it. This is the case whether the original account is an IRA or a 401 (k).
There are two different things to consider in this situation, including whether the inherited account is a Roth or the original version.
Distributions from Roth accounts are generally tax-free, while traditional accounts are taxed upon withdrawal. (Please note that if you inherit a Roth account that was opened for less than five years, any income that is withdrawn will be taxable, while the after-tax amount remains tax free.)
So if it’s a Roth and you’re not going to pay the tax on the distribution, regardless of when you spent 10 years it might be worth leaving the money there until the 10th year to be able to grow without it. Taxable
On the other hand, if it’s a traditional IRA or 401 (k), the tax side of the distribution should be assessed. Since the money is taxed as ordinary income, getting a lot of it at once can cost you much higher taxes. Over the past decade, the spread of distributions could reduce any tax hit in any year.
If you do not empty your account within 10 years, any assets remaining in the account may be fined 50%.
At the same time, heirs sometimes end up on retirement accounts through real estate, in other words, they are not the listed beneficiaries. But ended up with an account when the real estate went through probate and the property was distributed.
In this case, a different rule begins, typically the account must expire within five years if the original account holder did not initiate the RMD, according to Vanguard.If the RMD is pending, the heir is required to continue those withdrawals.
Spouses have more options when they take over the retirement account.
The first is to fund your own IRA, in which case you will follow the standard RMD rules, that is, when you turn 72, you will begin to make necessary withdrawals based on your own life expectancy.
“If a living spouse doesn’t want an income, this may turn out to be the best option because it may give them time for money to continue growing in their accounts,” said Ellen Becker of Shakespeare Wealth Management. say
However, he said this means that you will be subject to a 10% penalty for early withdrawal if you are under the age of 59 and withdraw money from that account.
The way to avoid that is to put the money into the inherited IRA and remain the beneficiary. In that case, you won’t be penalized.Plus, RMDs, which will be based on your life expectancy, don’t have to begin until the deceased spouse turns 72, Ellenbecker says.