Income Tax Burdens For the Non-Spouse Beneficiary: Perils of Failing to Roll a 401k into an IRA

<h1>Income Tax Burdens For the Non-Spouse Beneficiary: Perils of Failing to Roll a 401k into an IRA</h1>Author: <a title="James Lange" href="http://www.articlesbase.com/authors/james-lange/7472.htm">James Lange</a> Have you heard about a "stretch IRA" and wondered if it was some special kind of IRA? Well, it isn't. In the simplest terms, a stretch IRA is an IRA that has a beneficiary designation that provides for the possibility of maintaining the tax deferred status of the IRA after the death of the IRA owner. You might be thinking, "I wish I had a stretch IRA. I only named my spouse as my primary beneficiary and my kids as my successor or contingent beneficiary." Well, guess what? You have a stretch IRA. After your death, your spouse and/or your children could continue to defer income taxes for many years after your death, as long as they are prudent and only take the annual minimum required distributions mandated by law.

While the "stretch" concept applies to some retirement plans, many heirs of 401k owners could be in for a rude awakening if their parents fail to plan properly.

With proper planning you can put in place the mechanisms to stretch taxable distributions from an inherited IRA and certain retirement plans for decades, sometimes as long as 80 years after the original owner dies. If, however, the employer's retirement plan document stipulates the wrong provisions, the stretch may be replaced by a screaming income tax disaster. The heirs could be in for a tax nightmare if Dad never transferred his retirement plan into an IRA.

Many investors fail to realize that the specific plan rules that govern their individual 401k or other retirement plan take precedence over the IRS distribution rules for inherited IRAs or retirement plans.

The distribution rules that come into play at the death of the retirement plan owner are usually found in a plan document that few employees or advisors ever read. Many, if not most plan documents say that in the event of death, a non-spouse beneficiary must receive (and pay tax on) the entire balance of the retirement plan the year after the death of the retirement plan owner. These retirement plans don't allow a non-spouse beneficiary to stretch distributions. For example, if there is a $1 million balance, the non-spouse heir or heirs will have to pay income taxes on $1 million. Then, the remaining balance, roughly $650,000 ($1 million minus the $350,000 immediate income tax hit) would be outside of the tax-deferred protection of an inherited IRA.

Had the 401k participants taken that money and transferred it into an IRA before he died, the non-spouse beneficiary would have been able to stretch the distributions based on his or her life expectancy. Failing to make the IRA transfer will result in an unnecessary massive income tax burden for the non-spouse beneficiary. About the Author: Top IRA expert and author of <a href="http://www.retiresecure.com/">Retire Secure</a>!, James Lange, can keep you from jeopardizing your family's security. He has developed tax-savvy retirement and estate plans for over 1400 U.S. citizens with appreciable assets in their IRAs and 401(k) plans. Boost your family's financial security with a regular dose of great information. Sign up for his monthly Retire Secure newsletter at <a href="http://www.paytaxeslater.com"><a target="_blank" href="http://www.paytaxeslater.com">http://www.paytaxeslater.com</a></a>. Sign up now and get a free bonus report on the best order to spend your retirement assets. Article Source: <a href="http://www.articlesbase.com/">ArticlesBase.com</a> - <a href="http://www.articlesbase.com/taxes-articles/income-tax-burdens-for-the-nonspouse-beneficiary-perils-of-failing-to-roll-a-401k-into-an-ira-45721.html" title="Income Tax Burdens For the Non-Spouse Beneficiary: Perils of Failing to Roll a 401k into an IRA">Income Tax Burdens For the Non-Spouse Beneficiary: Perils of Failing to Roll a 401k into an IRA</a>

Have you heard about a "stretch IRA" and wondered if it was some special kind of IRA? Well, it isn't. In the simplest terms, a stretch IRA is an IRA that has a beneficiary designation that provides for the possibility of maintaining the tax deferred status of the IRA after the death of the IRA owner. You might be thinking, "I wish I had a stretch IRA. I only named my spouse as my primary beneficiary and my kids as my successor or contingent beneficiary." Well, guess what? You have a stretch IRA. After your death, your spouse and/or your children could continue to defer income taxes for many years after your death, as long as they are prudent and only take the annual minimum required distributions mandated by law.

While the "stretch" concept applies to some retirement plans, many heirs of 401k owners could be in for a rude awakening if their parents fail to plan properly.

With proper planning you can put in place the mechanisms to stretch taxable distributions from an inherited IRA and certain retirement plans for decades, sometimes as long as 80 years after the original owner dies. If, however, the employer's retirement plan document stipulates the wrong provisions, the stretch may be replaced by a screaming income tax disaster. The heirs could be in for a tax nightmare if Dad never transferred his retirement plan into an IRA.

Many investors fail to realize that the specific plan rules that govern their individual 401k or other retirement plan take precedence over the IRS distribution rules for inherited IRAs or retirement plans.

The distribution rules that come into play at the death of the retirement plan owner are usually found in a plan document that few employees or advisors ever read. Many, if not most plan documents say that in the event of death, a non-spouse beneficiary must receive (and pay tax on) the entire balance of the retirement plan the year after the death of the retirement plan owner. These retirement plans don't allow a non-spouse beneficiary to stretch distributions. For example, if there is a $1 million balance, the non-spouse heir or heirs will have to pay income taxes on $1 million. Then, the remaining balance, roughly $650,000 ($1 million minus the $350,000 immediate income tax hit) would be outside of the tax-deferred protection of an inherited IRA.

Had the 401k participants taken that money and transferred it into an IRA before he died, the non-spouse beneficiary would have been able to stretch the distributions based on his or her life expectancy. Failing to make the IRA transfer will result in an unnecessary massive income tax burden for the non-spouse beneficiary.

Top IRA expert and author of Retire Secure!, James Lange, can keep you from jeopardizing your family's security. He has developed tax-savvy retirement and estate plans for over 1400 U.S. citizens with appreciable assets in their IRAs and 401(k) plans. Boost your family's financial security with a regular dose of great information. Sign up for his monthly Retire Secure newsletter at http://www.paytaxeslater.com. Sign up now and get a free bonus report on the best order to spend your retirement assets.

Rate this Article:

2 / 5 stars - 1 vote(s)

Re-Publish

Article Source: http://www.articlesbase.com/taxes-articles/income-tax-burdens-for-the-nonspouse-beneficiary-perils-of-failing-to-roll-a-401k-into-an-ira-45721.html

Article Tags: Retirement Plan, 401k, Income Tax Burden, Stretch IRA

Related Videos
Related Articles
Ask / Related Q&A

Play

Loss Mitigation Plan Tax Consequences

Play

Tax Planning For Less

Play

How to Deduct Retirement Plan Contributions

Play

How To Leave Your IRA To Your Children Tax Free

Play

Grading the Stimulus Plan (Morningstar)

Latest Taxes Articles
More from James Lange

Alternative Minimum Tax Planning Ideas...Year-End AMT Planning Wrap-Up - Part 2

By: George Bauernfeind | 01/01/2010
The AMT items that were talked about in Part 1 of this wrap-up generally were the bigger ones that can, depending on a taxpayer’s situation, present immediate year-end Alternative Minimum Tax savings opportunities. But the other items that were discussed in this 10-week series also are important in making sure the least amount of AMT is paid. Here is a brief recap of these other items, with references to the amtblog.com articles in which each appeared.

Alternative Minimum Tax Planning Ideas...Investment - Private Activity Bonds

By: George Bauernfeind | 01/01/2010
Municipal bonds, or "muni bonds" as they are commonly referred to, offer favorable tax treatment in that the interest earned on them is not subject to tax. This tax-free yield can make them an attractive investment. If an investor is not careful, however, the AMT can apply to make certain muni bonds fully taxable. Unfortunately, many taxpayers discover this only after making the investment.

Filing your Own Taxes, Preparations and Considerations Part Two

By: Kasan Groupe | 31/12/2009
This is a follow up to Filing your Taxes, Preparations and Considerations Part One. Yes, finally! That time of the year is finally here when you can save a little bit of your wages and tuck the rest in a piggy bank. You can raise your glass and jump on your kids’ bunk beds in glee, It’s Tax Season! But have you ever considered filed your own? If not, there are many options to consider. It may or may not be the best route for you.

Filing your Own Taxes, Preparations and Considerations Part One

By: Kasan Groupe | 31/12/2009
Yes, finally! That time of the year is finally here when you can save a little bit of your wages and tuck the rest in a piggy bank. You can raise your glass and jump on your kids’ bunk beds in glee, It’s Tax Season! But have you ever considered filed your own? If not, there are many options to consider. It may or may not be the best route for you.

How to Get Tax Help with Your Offshore Bank Account if You Missed the FBAR Amnesty Deadline for IRS Voluntary Disclosure

By: Brian Compton | 31/12/2009
FBAR tax penalties can amount to as much as 200-300% of the asset value of the offshore account. If you have an offshore account and missed the IRS's Foreign Bank and Financial Accounts (FBAR) amnesty deadline on October 15th, it’s not too late to have your FBAR tax attorney or tax resolution specialist draft a voluntary disclosure to mount your offshore account tax evasion defense.

Can't Pay Your Back Taxes? Get Tax Help to Make the IRS an Offer They Can't Refuse

By: Michael Rozbruch | 31/12/2009
Even if you can't pay your back taxes, a Certified Tax Resolution Specialist who is a tax attorney or CPA, can give you the help you need to settle your debt including negotiating a reasonable monthly payment plan or an offer in compromise settlement that pays a fraction of what is owed. If your IRS bill from back taxes is too much to handle, only a seasoned tax attorney, CPA or Certified Tax Resolution Specialist can provide tax help to show you the proper sequence of events to declare bankrupt

What Are The Roth IRA Limits?

By: Ricky Lim | 31/12/2009
Roth Ira is among the best available savings and investments accounts available in the United States. The Roth Ira is very advantageous to users since it does not attract any tax; tax deferments do not apply to this kind of the savings plan.

Free Tax Filing For The Military

By: Chintamani | 30/12/2009
Active duty members of the United States Military can have their taxes prepared and filed free of charge. This service is available on military bases worldwide through Volunteer Income Tax Assistance (VITA) personnel.

Financial Planning Advice: 401(k) Rollover Information your Financial Planner Might not Want to Tell You…

By: James Lange | 16/12/2006 | Taxes
The recent Pension Protection Act 401(k) - Rollover Information on what the new law offers.

Ira & Retirement Planning Mistakes: Don't Fall Victim to Bad Ira and Retirement Plan Advice

By: James Lange | 03/11/2006 | Taxes
Lack of knowledge in the IRA & retirement plan area can cost hundreds of thousands or even millions of dollars. Here Are some of the most common IRA & Retirement Planning Mistakes That Can Accelerate Acceleration of Income Taxes.

Saving for Retirement: Compound and Grow your Employer Matching Retirement Plan

By: James Lange | 03/08/2006 | Business
If your employer offers a matching contribution to your retirement plan, the cardinal rule is: contribute whatever the employer is willing to match. Even if your employer is only willing to make a partial match up to a cap, you should still take advantage of this opportunity.

Income Tax Burdens For the Non-Spouse Beneficiary: Perils of Failing to Roll a 401k into an IRA

By: James Lange | 03/08/2006 | Taxes
With proper planning you can put in place the mechanisms to stretch taxable distributions from an inherited IRA. The distribution rules that come into play at the death of the retirement plan owner are usually found in a plan document that few employees or advisors ever read.