The Pension Protection Act gives 401(k) beneficiaries reprieve from tax burden.
Among the 900-pages of the Pension Protection Act of 2006 lies good news for non spousal beneficiaries of 401(k) plans. The act grants such beneficiaries the ability to roll 401(k) funds they've inherited directly into a new inherited IRA established specifically to receive the 401(k) funds.
Spouses have always had this option, including the ability to roll the 401(k) balance into their own IRA. Non spouse beneficiaries had to receive the 401(k) funds in whatever manner the plan documents prescribed - usually a lump sum distribution, creating an immediate state and federal tax burden and potentially pushing the beneficiary into a higher income tax bracket.
Beginning in 2007, non spouse beneficiaries can move the funds to an IRA according to the rules:
1. The transfer must be directly from the 401(k) to the IRA. If the beneficiary receives a check, taxes kick in, even if the beneficiary deposits the check into the IRA.
2. The IRA must be an inherited IRA in the original 401(k) participant's name, with the recipient as beneficiary - in other words, the IRA must be titled exactly like the 401(k) account. The 401(k) funds cannot be transferred to the beneficiary's existing IRA.
3. The beneficiary must be a person or group of people, which can include a trust for the benefit of the beneficiary. The 401(k) funds cannot be transferred to the participant's estate.
4. The beneficiary must take required minimum distribution over his or her life expectancy. Those distributions are taxed as they are taken.
Beneficiaries got another boon with the expansion of rules for 401(k) hardship withdrawals. Existing law allows hardship withdrawals only for the participant, the spouse and legal dependents. The new rules allow participants to withdraw hardship funds for any person listed as a beneficiary of the 401(k).
The above changes also apply to 403(b) plans, typically available to teachers, and 457 retirement savings accounts for government employees.
An IRA typically will offer more choices than a 401(k) plan. Your financial professional can guide you in selecting investment options for the IRA and help you avoid any missteps in receiving and transferring your 401(K) inheritance.
Lawrence D. Sprung, CFP of Mitlin Financial Inc., is a Registered Representative with Securities America, Inc., a Registered Broker/Dealer, member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc., a SEC Registered Investment Advisory firm. Lawrence D. Sprung, Investment Advisor Representative. Mitlin Financial Inc. and Securities America are unaffiliated. Written by: Securities America, Inc. Distributed by: Lawrence D. Sprung.
He can be reached at (631) 465-2017 or by e-mail at lsprung@mitlinfinancial.com. Feel free to forward any questions, or future topics you would like to see discussed to info@mitlinfinancial.com and put longisland.com in the subject line.