Disbursements of 401K prior to death

[runkpanole]

My dad mentioned that he may start dispersing his retirement account to his children prior to his death. He’s not in great health, but not terminal either. I have concerns. While I’d love the money to put into my kids 529, I want to make sure he isn’t giving away his stuff too early. He still has a pension and social security. Minimal bills at this time (no house payment, small car payment) and really good health coverage with Medicare and a supplement. What kind of issues am I not considering? Taxes? Early withdrawal before 70 (not sure of the right age)? Other than the obvious concern of him cutting himself short?

 

[Funky Bunch]

It doesn't have to be all or none. Maybe a good idea would be to gift the kids something under the annual limit for having to file a gift tax return. See how that goes and then do the same next year. One pro I can see in doing this is that on the flipside of inheriting the 401K, you'd have to have it all withdrawn within 10 years.

 

[DogBoyRy]

My dad mentioned that he may start dispersing his retirement account to his children prior to his death. He’s not in great health, but not terminal either. I have concerns. While I’d love the money to put into my kids 529, I want to make sure he isn’t giving away his stuff too early. He still has a pension and social security. Minimal bills at this time (no house payment, small car payment) and really good health coverage with Medicare and a supplement. What kind of issues am I not considering? Taxes? Early withdrawal before 70 (not sure of the right age)? Other than the obvious concern of him cutting himself short?

Taxes are unavoidable.
He could start taking $$ out now but he should look at total income so he doesn’t bump up to a high rate.
Gifting to family is a whole other subject…

 

[artradley]

My dad mentioned that he may start dispersing his retirement account to his children prior to his death. He’s not in great health, but not terminal either. I have concerns. While I’d love the money to put into my kids 529, I want to make sure he isn’t giving away his stuff too early. He still has a pension and social security. Minimal bills at this time (no house payment, small car payment) and really good health coverage with Medicare and a supplement. What kind of issues am I not considering? Taxes? Early withdrawal before 70 (not sure of the right age)? Other than the obvious concern of him cutting himself short?

No penalty after age 59 1/2.

But unless his children need the money there isn’t really any reason to do it, other than I suppose nursing homes that want you to deplete all of your assets. I guess your mom is no longer around?

 

[RileyHawk]

Taxes are unavoidable.
He could start taking $$ out now but he should look at total income so he doesn’t bump up to a high rate.
Gifting to family is a whole other subject…

That's not necessarily true. Depends on the type of 401K it is. If it is a Roth the taxes have already been paid and there are no taxes on withdrawals.

He will have gift tax if he gives any one person more than $18K in 2024.

 

[RileyHawk]

No penalty after age 59 1/2.

But unless his children need the money there isn’t really any reason to do it, other than I suppose nursing homes that want you to deplete all of your assets. I guess your mom is no longer around?

There is if you want the children to avoid inheritance taxes.

 

[artradley]

There is if you want the children to avoid inheritance taxes.

Almost zero percent chance of inheritance tax. Have you been listening to GOP talking points?

 

[jonesy5960]

That's not necessarily true. Depends on the type of 401K it is. If it is a Roth the taxes have already been paid and there are no taxes on withdrawals.

He will have gift tax if he gives any one person more than $18K in 2024.

If he's still married that number is $36k. Maybe he needs an advisor?

 

[markfromj]

That's not necessarily true. Depends on the type of 401K it is. If it is a Roth the taxes have already been paid and there are no taxes on withdrawals.

He will have gift tax if he gives any one person more than $18K in 2024.

No. The first $12.4 M is free of gift tax (lifetime number).

But, above $18k (I thought it was 17) requires you to file that you gave that (but you pay no tax).

 

[RileyHawk]

Almost zero percent chance of inheritance tax. Have you been listening to GOP talking points?

There is on an inherited non-Roth 401K. The 401K has to be either liquidated completely (and taxes taken out) or rolled into a Beneficiary IRA with taxable RMAs that have to taken to disperse the account within 10 years, I believe.

 

[artradley]

There is on an inherited non-Roth 401K. The 401K has to be either liquidated completely (and taxes taken out) or rolled into a Beneficiary IRA with taxable RMAs that have to taken to disperse the account within 10 years, I believe.

There is no inheritance tax.

 

[RileyHawk]

If he's still married that number is $36k. Maybe he needs an advisor?

It's true that he and his spouse can each give $18K to an individual without inflicting the gift tax but I'm not sure that it can come directly from the 401K as that is likely only in his name. In any event, yes, he should work with an expert.

 

[RileyHawk]

There is no inheritance tax.

There are taxes to pay on retirement accounts that are liquidated at death. Otherwise people could pay into IRAs and 401Ks without ever paying tax on them and have them roll to their heirs tax free. That's not how it works.

 

[runkpanole]

No penalty after age 59 1/2.

But unless his children need the money there isn’t really any reason to do it, other than I suppose nursing homes that want you to deplete all of your assets. I guess your mom is no longer around?

She passed last year.

 

[artradley]

There are taxes to pay on retirement accounts that are liquidated at death. Otherwise people could pay into IRAs and 401Ks without ever paying tax on them and have them roll to their heirs tax free. That's not how it works.

Those are called income tax.

 

[runkpanole]

If he's still married that number is $36k. Maybe he needs an advisor?

He’s talking to his advisor next week. I thought the good people of HORT would know more. 😂

 

[Funky Bunch]

No. The first $12.4 M is free of gift tax (lifetime number).

But, above $18k (I thought it was 17) requires you to file that you gave that (but you pay no tax).

It's up to 13.6 M this year, which should be a relief to HORTers.

 

[RileyHawk]

Those are called income tax.

And an inherited 401K is considered income. I'm not sure what you're arguing here.

Options for an inherited 401(k) if you are a non spouse beneficiary​

Take a lump-sum distribution

Non spouse beneficiaries can receive their portion of a 401(k) account as a lump sum with the same guidelines as a spouse beneficiary. Note: Once a lump sum is taken, the 401(k) balance cannot be rolled over.

A spouse can receive their portion of a 401(k) account as a lump sum, penalty-free. The IRS taxes lump-sum distributions as ordinary income (except for any Roth IRA that has met certain requirements2), and, depending on the account balance and your income level, this could create a substantial tax bill.

Roll over funds into an inherited IRA

Non spouse beneficiaries can also do a direct trustee-to-trustee transfer of inherited 401(k) funds into an inherited IRA, following rules similar to inheriting someone's IRA. The IRS waives any early withdrawal penalties for owners of inherited IRAs so they can withdraw at any time.

Some rules about this option: First, the non spouse beneficiary can't make additional contributions to an inherited IRA. Second, unlike a spouse beneficiary who has a more flexible schedule to empty an inherited IRA, certain non spouse beneficiaries will need to withdraw all funds in an inherited IRA opened after January 1, 2020, no later than 10 years after the original account owner's death. IRS regulations require RMDs during the 10-year period to be taken at least as often as they would have been taken under the original owner's remaining life expectancy, (as opposed to inheriting before RMDs commenced, which would allow not withdrawing any money in years 1–9, then draining the account all in one go in year 10.) Thus, if the owner was age 73 or would have reached age 73 during the 10-year period, the beneficiary must take RMDs accordingly within the 9 years and take the final distribution in the 10th year.

The penalty for not emptying the account within 10 years is 25% of the remaining account balance, which can be reduced to 10% if corrected within 2 years.

 

[DogBoyRy]

That's not necessarily true. Depends on the type of 401K it is. If it is a Roth the taxes have already been paid and there are no taxes on withdrawals.

He will have gift tax if he gives any one person more than $18K in 2024.

I assumed it was not a roth.
Gift tax applies to traceable gifts wink wink.

 

[artradley]

And an inherited 401K is considered income. I'm not sure what you're arguing here.

Options for an inherited 401(k) if you are a non spouse beneficiary​

Take a lump-sum distribution

Non spouse beneficiaries can receive their portion of a 401(k) account as a lump sum with the same guidelines as a spouse beneficiary. Note: Once a lump sum is taken, the 401(k) balance cannot be rolled over.

A spouse can receive their portion of a 401(k) account as a lump sum, penalty-free. The IRS taxes lump-sum distributions as ordinary income (except for any Roth IRA that has met certain requirements2), and, depending on the account balance and your income level, this could create a substantial tax bill.

Roll over funds into an inherited IRA

Non spouse beneficiaries can also do a direct trustee-to-trustee transfer of inherited 401(k) funds into an inherited IRA, following rules similar to inheriting someone's IRA. The IRS waives any early withdrawal penalties for owners of inherited IRAs so they can withdraw at any time.

Some rules about this option: First, the non spouse beneficiary can't make additional contributions to an inherited IRA. Second, unlike a spouse beneficiary who has a more flexible schedule to empty an inherited IRA, certain non spouse beneficiaries will need to withdraw all funds in an inherited IRA opened after January 1, 2020, no later than 10 years after the original account owner's death. IRS regulations require RMDs during the 10-year period to be taken at least as often as they would have been taken under the original owner's remaining life expectancy, (as opposed to inheriting before RMDs commenced, which would allow not withdrawing any money in years 1–9, then draining the account all in one go in year 10.) Thus, if the owner was age 73 or would have reached age 73 during the 10-year period, the beneficiary must take RMDs accordingly within the 9 years and take the final distribution in the 10th year.

The penalty for not emptying the account within 10 years is 25% of the remaining account balance, which can be reduced to 10% if corrected within 2 years.

I am arguing that there is no inheritance tax in this case. Because most Americans mistakenly believe there is. But unless your estate is something like $15M there is no federal estate tax, and in most states there is no estate/inheritance tax, at all.

Certainly if we assume “dad” is in a lower tax bracket than his children and he disperses the money under the gift level (whatever that may be) there can be some degree of tax advantage to gifting his kids money now. But that is an income tax strategy and has nothing to do with any mythical inheritance tax.

It is important that people understand the difference.

 

[StormHawk42]

And an inherited 401K is considered income. I'm not sure what you're arguing here.

Options for an inherited 401(k) if you are a non spouse beneficiary​

Take a lump-sum distribution

Non spouse beneficiaries can receive their portion of a 401(k) account as a lump sum with the same guidelines as a spouse beneficiary. Note: Once a lump sum is taken, the 401(k) balance cannot be rolled over.

A spouse can receive their portion of a 401(k) account as a lump sum, penalty-free. The IRS taxes lump-sum distributions as ordinary income (except for any Roth IRA that has met certain requirements2), and, depending on the account balance and your income level, this could create a substantial tax bill.

Roll over funds into an inherited IRA

Non spouse beneficiaries can also do a direct trustee-to-trustee transfer of inherited 401(k) funds into an inherited IRA, following rules similar to inheriting someone's IRA. The IRS waives any early withdrawal penalties for owners of inherited IRAs so they can withdraw at any time.

Some rules about this option: First, the non spouse beneficiary can't make additional contributions to an inherited IRA. Second, unlike a spouse beneficiary who has a more flexible schedule to empty an inherited IRA, certain non spouse beneficiaries will need to withdraw all funds in an inherited IRA opened after January 1, 2020, no later than 10 years after the original account owner's death. IRS regulations require RMDs during the 10-year period to be taken at least as often as they would have been taken under the original owner's remaining life expectancy, (as opposed to inheriting before RMDs commenced, which would allow not withdrawing any money in years 1–9, then draining the account all in one go in year 10.) Thus, if the owner was age 73 or would have reached age 73 during the 10-year period, the beneficiary must take RMDs accordingly within the 9 years and take the final distribution in the 10th year.

The penalty for not emptying the account within 10 years is 25% of the remaining account balance, which can be reduced to 10% if corrected within 2 years.

What you posted is right but that’s all ordinary income tax. Inheritance taxes are entirely different.

 

[RileyHawk]

I am arguing that there is no inheritance tax in this case. Because most Americans mistakenly believe there is. But unless your estate is something like $15M there is no federal estate tax, and in most states there is no estate/inheritance tax, at all.

Certainly if we assume “dad” is in a lower tax bracket than his children and he disperses the money under the gift level (whatever that may be) there can be some degree of tax advantage to gifting his kids money now. But that is an income tax strategy and has nothing to do with any mythical inheritance tax.

It is important that people understand the difference.

There was no "inheritance" tax on this in any case. But there are taxes to be paid if someone inherits a 401K or IRA. Suggesting that there is no tax on this because they won't hit the inheritance tax level is incorrect. And it has everything to do with the inheritance of the money and the taxes that will be owed.

 

[StormHawk42]

To answer the OP, the taxes will be paid by your dad when he withdraws it, even if he gifts it to someone else. The only way you can avoid income tax on traditional 401k/IRA withdrawals is to 1) donate it to charity (up to $100k) or 2) die with it in which case your beneficiaries will pay it.

 

[RileyHawk]

What you posted is right but that’s all ordinary income tax. Inheritance taxes are entirely different.

It's the taxes that will be owed on inherited money. The notion that no taxes will be owed if he inherits his father's 401K is incorrect.

 

[StormHawk42]

It's the taxes that will be owed on inherited money. The notion that no taxes will be owed if he inherits his father's 401K is incorrect.

I don’t think that’s what he was saying. He was saying that the taxes are “income” taxes, not “inheritance” taxes, which is accurate. Income tax and inheritance tax are two different taxes.

You guys are both right but he used the correct terminology.

 

[HawkMachine]

There is if you want the children to avoid inheritance taxes.

Stop replying in this thread moron.

You clearly don't know chit about taxes.

 

[HawkMachine]

He will have gift tax if he gives any one person more than $18K in 2024.

Damn you are dumb.

 

[Funky Bunch]

There was no "inheritance" tax on this in any case. But there are taxes to be paid if someone inherits a 401K or IRA. Suggesting that there is no tax on this because they won't hit the inheritance tax level is incorrect. And it has everything to do with the inheritance of the money and the taxes that will be owed.

I think "inheritance tax" makes it sound like tax is taken out before you even see it. But there's also no guarantee that you'll pay a penny on this even when it becomes income. If you can time it right and couple the distributions with Roth withdrawals, savings, money from a taxable account, etc, you could take out 20K+ per year from an inherited IRA and stay in the 0% bracket with just the standard deduction (married) after you retire.

 

[RileyHawk]

I don’t think that’s what he was saying. He was saying that the taxes are “income” taxes, not “inheritance” taxes, which is accurate. Income tax and inheritance tax are two different taxes.

You guys are both right but he used the correct terminology.

I don't think the OP cares what the taxes are technically called. I believe he was inquiring about what the tax and other consequences are on 401Ks and gifts.

 

[SeaPA]

If he has little other income, it probably makes sense for him to at least start getting some of the $ out if he has a good bit in the retirement account (whether or not he subsequently gifts it to you & your siblings)....main reason being that if he doesn't have much income other than SS benefits, he can get a chunk out at a relatively low tax rate. If it's still in the retirement account when he dies, the beneficiaries who inherit have 10 years to drain it. Often, that happens when the heirs are in their peak earning years - so they end up having to withdraw it at a higher tax bracket than the parent would've paid.
Another alternative would be to have him do some Roth conversions, especially if the funds are just going to get invested when they come out of the retirement account (i.e. if he's going to move it from retirement account to his brokerage account, or he's going to withdraw from the retirement account, gift it to you, and you drop it into an investment account). If he converts it to a Roth, he'd pay tax now, but all future growth is tax-free to both him and his heirs.
>>>Note, the above assumes it's in a regular IRA/401k/403b, not already in a Roth<<<

 

[RileyHawk]

I think "inheritance tax" makes it sound like tax is taken out before you even see it. But there's also no guarantee that you'll pay a penny on this even when it becomes income. If you can time it right and couple the distributions with Roth withdrawals, savings, money from a taxable account, etc, you could take out 20K+ per year from an inherited IRA and stay in the 0% bracket with just the standard deduction (married) after you retire.

On a Roth 401K there are options but on a standard 401K the withdrawals are taxed as ordinary income. If it is inherited you can roll it into a specific Beneficiary IRA that has to be liquidated within 10 years and those withdrawals are taxed as ordinary income.

 

[DogBoyRy]

On a Roth 401K there are options but on a standard 401K the withdrawals are taxed as ordinary income. If it is inherited you can roll it into a specific Beneficiary IRA that has to be liquidated within 10 years and those withdrawals are taxed as ordinary income.

This can then result in higher taxes in some cases.

 

[HawkMachine]

My dad mentioned that he may start dispersing his retirement account to his children prior to his death. He’s not in great health, but not terminal either. I have concerns. While I’d love the money to put into my kids 529, I want to make sure he isn’t giving away his stuff too early. He still has a pension and social security. Minimal bills at this time (no house payment, small car payment) and really good health coverage with Medicare and a supplement. What kind of issues am I not considering? Taxes? Early withdrawal before 70 (not sure of the right age)? Other than the obvious concern of him cutting himself short?

I have several clients that would rather pay the income tax vs having their kids pay the tax.

It's also a way for his kids and grandkids to get the financial benefit sooner than later.

As long as he has enough to live on, I see no disadvantage of him doing this. Unless he's already in a high bracket and the kids are not.

This is in regards to retirement accounts.

Now, if he has nonqualified assets that have appreciated, I would NOT sell those. Best thing to do with those is die with them and then the beneficiaries get a stepped up basis. Which pretty much means you kids would get it all tax free if sold.

 

[RileyHawk]

This can then result in higher taxes in some cases.

Yes, which is why it makes sense to hire a professional.

 

[DogBoyRy]

Yes, which is why it makes sense to hire a professional.

Or just read the rules on distributions.

 

[RileyHawk]

Or just read the rules on distributions.

There's more to it than that but have at it. Don't forget to do the math on the current tax brackets and then look at your crystal ball on future tax brackets. Perhaps it is such a low number it doesn't matter much. I do know that people much smarter than you have struggled with this.

 

[cheeselog8]

Start doing annual Roth conversions to at least to fill up his 12% tax bracket. It ain't getting any cheaper than that. Even the next 22% bracket isn't bad, historically speaking.

 

[RileyHawk]

Start doing annual Roth conversions to at least to fill up his 12% tax bracket. It ain't getting any cheaper than that. Even the next 22% bracket isn't bad, historically speaking.

You can do withdrawals and contribute up to the yearly max into a Roth but to do a conversion (which is converting more $$ than the yearly limit) is a one time thing. Plan wisely.

 

[DogBoyRy]

There's more to it than that but have at it. Don't forget to do the math on the current tax brackets and then look at your crystal ball on future tax brackets. Perhaps it is such a low number it doesn't matter much. I do know that people much smarter than you have struggled with this.

Yeah the math can get complicated.
I/we had to take out an inherited ira in stages to avoid getting into the top brackets.
First thing we did and would recommend is convert it into a self directed inherited ira ( scwab is great and easy).

 

[RileyHawk]

Yeah the math can get complicated.
I/we had to take out an inherited ira in stages to avoid getting into the top brackets.
First thing we did and would recommend is convert it into a self directed inherited ira ( scwab is great and easy).

Self directed or not you have to meet the RMAs and get it all out within 10 years.

All in all it's a good problem to have but should be run past an expert to avoid paying more in taxes than required.