You Inherited a Retirement Account: Now What?

June 2, 2021 by rpmarket1@gmail.com

For decades, common financial planning wisdom has encouraged almost all American workers to maximize their contributions to qualified retirement accounts. Indeed, doing so can be a powerful way to reduce your current income tax liability, grow your savings exponentially tax-free, and, in most states, protect your savings from claims of creditors. And by and large, this is what most American workers have done.

The result is that Americans have gradually amassed huge amounts of wealth in these types of qualified plans. It is increasingly common for an IRA or 401k to be the highest value item of property that an American owns. For purposes of estate planning, however, it is important to understand that very special rules apply to these types of accounts. Gone are the days when you can write up a quick will or trust and be assured that everything you own will pass to your heirs or beneficiaries according to the terms of those legal documents. Instead, it has become critically important for families to understand both the laws applicable to wills and trusts and the complex laws governing retirement plans. Failure to understand these laws can exact a heavy price. The following are some of the crucial considerations if you end up inheriting a qualified retirement plan.

Obtain Professional Advice Before Filing a Claim

If a loved one dies owning a qualified retirement plan such as an IRA or 401k, and if you suspect that you are a beneficiary of that plan, the first thing you should do is contact the financial institution or custodian of the plan as soon as possible. Often a copy of the retirement plan statement will include contact information for the financial institution where the retirement plan is held. You should speak with the beneficiary claims department and let them know that you believe you may be a beneficiary on your loved one’s retirement account. Financial institutions typically will not confirm or deny beneficiary status over the phone. However, they will confirm certain information with you such as your full name, date of birth, address, and possibly your Social Security number. They will also typically request that you provide them with a copy of the plan owner’s death certificate. If you are confirmed to be a beneficiary, they will send you a copy of a beneficiary claim form at the address that is listed in their system.

Once you obtain the claim form, you should read it carefully and seek the advice of a competent tax professional such as your CPA, your estate planning attorney, or your financial advisor. These professionals can help you understand the various options that such beneficiary claim forms provide.

For example, most claim forms allow at least three options for making a beneficiary claim:

A lump-sum payout of the plan proceeds to which you are entitled
Establishing an inherited IRA account with the same financial institution
Making a trustee-to-trustee transfer of the plan benefits to another institution that will receive the benefits as an inherited IRA or a spousal rollover

Depending on the financial institution, additional options may be available. If you choose to take a lump-sum payout of the plan proceeds, it is critical to remember that qualified retirement plans (with the exception of Roth IRAs) have not yet been subject to income tax. Thus, if you withdraw the plan proceeds in the form of cash (or a check that is sent to you) and you deposit that check, you will be responsible for paying income tax on every dollar that is deposited into your bank account. The financial institution will notify the IRS that the payout was made to you, and you will receive a 1099 form from the financial institution at the end of the year for your own income tax reporting purposes. Depending on your annual income, this additional income might easily push you into a higher tax bracket and create significant income tax liability for that year.

As a result of this potential tax liability, many of the beneficiary claim forms will ask you whether you want to withhold a percentage of the payout for payment of income tax. The financial institution may automatically determine the amount that is withheld, or it may allow you to specify how much to withhold. If you have the option of determining how much to withhold, you would be wise to seek the advice of an income tax professional to help you determine the appropriate amount.

Before Taking a Lump-Sum Payout, Consider This

If a loved one dies owning a qualified retirement plan such as an IRA or 401k, and if you suspect that you are a beneficiary of that plan, the first thing you should do is contact the financial institution or custodian of the plan as soon as possible. Often a copy of the retirement plan statement will include contact information for the financial institution where the retirement plan is held. You should speak with the beneficiary claims department and let them know that you believe you may be a beneficiary on your loved one’s retirement account. Financial institutions typically will not confirm or deny beneficiary status over the phone. However, they will confirm certain information with you such as your full name, date of birth, address, and possibly your Social Security number. They will also typically request that you provide them with a copy of the plan owner’s death certificate. If you are confirmed to be a beneficiary, they will send you a copy of a beneficiary claim form at the address that is listed in their system.

Once you obtain the claim form, you should read it carefully and seek the advice of a competent tax professional such as your CPA, your estate planning attorney, or your financial advisor. These professionals can help you understand the various options that such beneficiary claim forms provide.

For example, most claim forms allow at least three options for making a beneficiary claim:

A lump-sum payout of the plan proceeds to which you are entitled
Establishing an inherited IRA account with the same financial institution
Making a trustee-to-trustee transfer of the plan benefits to another institution that will receive the benefits as an inherited IRA or a spousal rollover

Depending on the financial institution, additional options may be available. If you choose to take a lump-sum payout of the plan proceeds, it is critical to remember that qualified retirement plans (with the exception of Roth IRAs) have not yet been subject to income tax. Thus, if you withdraw the plan proceeds in the form of cash (or a check that is sent to you) and you deposit that check, you will be responsible for paying income tax on every dollar that is deposited into your bank account. The financial institution will notify the IRS that the payout was made to you, and you will receive a 1099 form from the financial institution at the end of the year for your own income tax reporting purposes. Depending on your annual income, this additional income might easily push you into a higher tax bracket and create significant income tax liability for that year.

As a result of this potential tax liability, many of the beneficiary claim forms will ask you whether you want to withhold a percentage of the payout for payment of income tax. The financial institution may automatically determine the amount that is withheld, or it may allow you to specify how much to withhold. If you have the option of determining how much to withhold, you would be wise to seek the advice of an income tax professional to help you determine the appropriate amount.

Spouse of IRA Owner

If a loved one dies owning a qualified retirement plan such as an IRA or 401k, and if you suspect that you are a beneficiary of that plan, the first thing you should do is contact the financial institution or custodian of the plan as soon as possible. Often a copy of the retirement plan statement will include contact information for the financial institution where the retirement plan is held. You should speak with the beneficiary claims department and let them know that you believe you may be a beneficiary on your loved one’s retirement account. Financial institutions typically will not confirm or deny beneficiary status over the phone. However, they will confirm certain information with you such as your full name, date of birth, address, and possibly your Social Security number. They will also typically request that you provide them with a copy of the plan owner’s death certificate. If you are confirmed to be a beneficiary, they will send you a copy of a beneficiary claim form at the address that is listed in their system.

Once you obtain the claim form, you should read it carefully and seek the advice of a competent tax professional such as your CPA, your estate planning attorney, or your financial advisor. These professionals can help you understand the various options that such beneficiary claim forms provide.

For example, most claim forms allow at least three options for making a beneficiary claim:

A lump-sum payout of the plan proceeds to which you are entitled
Establishing an inherited IRA account with the same financial institution
Making a trustee-to-trustee transfer of the plan benefits to another institution that will receive the benefits as an inherited IRA or a spousal rollover

Depending on the financial institution, additional options may be available. If you choose to take a lump-sum payout of the plan proceeds, it is critical to remember that qualified retirement plans (with the exception of Roth IRAs) have not yet been subject to income tax. Thus, if you withdraw the plan proceeds in the form of cash (or a check that is sent to you) and you deposit that check, you will be responsible for paying income tax on every dollar that is deposited into your bank account. The financial institution will notify the IRS that the payout was made to you, and you will receive a 1099 form from the financial institution at the end of the year for your own income tax reporting purposes. Depending on your annual income, this additional income might easily push you into a higher tax bracket and create significant income tax liability for that year.

As a result of this potential tax liability, many of the beneficiary claim forms will ask you whether you want to withhold a percentage of the payout for payment of income tax. The financial institution may automatically determine the amount that is withheld, or it may allow you to specify how much to withhold. If you have the option of determining how much to withhold, you would be wise to seek the advice of an income tax professional to help you determine the appropriate amount.

Non-Spouse Beneficiaries

If a loved one dies owning a qualified retirement plan such as an IRA or 401k, and if you suspect that you are a beneficiary of that plan, the first thing you should do is contact the financial institution or custodian of the plan as soon as possible. Often a copy of the retirement plan statement will include contact information for the financial institution where the retirement plan is held. You should speak with the beneficiary claims department and let them know that you believe you may be a beneficiary on your loved one’s retirement account. Financial institutions typically will not confirm or deny beneficiary status over the phone. However, they will confirm certain information with you such as your full name, date of birth, address, and possibly your Social Security number. They will also typically request that you provide them with a copy of the plan owner’s death certificate. If you are confirmed to be a beneficiary, they will send you a copy of a beneficiary claim form at the address that is listed in their system.

Once you obtain the claim form, you should read it carefully and seek the advice of a competent tax professional such as your CPA, your estate planning attorney, or your financial advisor. These professionals can help you understand the various options that such beneficiary claim forms provide.

For example, most claim forms allow at least three options for making a beneficiary claim:

A lump-sum payout of the plan proceeds to which you are entitled
Establishing an inherited IRA account with the same financial institution
Making a trustee-to-trustee transfer of the plan benefits to another institution that will receive the benefits as an inherited IRA or a spousal rollover

Depending on the financial institution, additional options may be available. If you choose to take a lump-sum payout of the plan proceeds, it is critical to remember that qualified retirement plans (with the exception of Roth IRAs) have not yet been subject to income tax. Thus, if you withdraw the plan proceeds in the form of cash (or a check that is sent to you) and you deposit that check, you will be responsible for paying income tax on every dollar that is deposited into your bank account. The financial institution will notify the IRS that the payout was made to you, and you will receive a 1099 form from the financial institution at the end of the year for your own income tax reporting purposes. Depending on your annual income, this additional income might easily push you into a higher tax bracket and create significant income tax liability for that year.

As a result of this potential tax liability, many of the beneficiary claim forms will ask you whether you want to withhold a percentage of the payout for payment of income tax. The financial institution may automatically determine the amount that is withheld, or it may allow you to specify how much to withhold. If you have the option of determining how much to withhold, you would be wise to seek the advice of an income tax professional to help you determine the appropriate amount.

Do not Forget to Name Beneficiaries of Your Own

If a loved one dies owning a qualified retirement plan such as an IRA or 401k, and if you suspect that you are a beneficiary of that plan, the first thing you should do is contact the financial institution or custodian of the plan as soon as possible. Often a copy of the retirement plan statement will include contact information for the financial institution where the retirement plan is held. You should speak with the beneficiary claims department and let them know that you believe you may be a beneficiary on your loved one’s retirement account. Financial institutions typically will not confirm or deny beneficiary status over the phone. However, they will confirm certain information with you such as your full name, date of birth, address, and possibly your Social Security number. They will also typically request that you provide them with a copy of the plan owner’s death certificate. If you are confirmed to be a beneficiary, they will send you a copy of a beneficiary claim form at the address that is listed in their system.

Once you obtain the claim form, you should read it carefully and seek the advice of a competent tax professional such as your CPA, your estate planning attorney, or your financial advisor. These professionals can help you understand the various options that such beneficiary claim forms provide.

For example, most claim forms allow at least three options for making a beneficiary claim:

A lump-sum payout of the plan proceeds to which you are entitled
Establishing an inherited IRA account with the same financial institution
Making a trustee-to-trustee transfer of the plan benefits to another institution that will receive the benefits as an inherited IRA or a spousal rollover

Depending on the financial institution, additional options may be available. If you choose to take a lump-sum payout of the plan proceeds, it is critical to remember that qualified retirement plans (with the exception of Roth IRAs) have not yet been subject to income tax. Thus, if you withdraw the plan proceeds in the form of cash (or a check that is sent to you) and you deposit that check, you will be responsible for paying income tax on every dollar that is deposited into your bank account. The financial institution will notify the IRS that the payout was made to you, and you will receive a 1099 form from the financial institution at the end of the year for your own income tax reporting purposes. Depending on your annual income, this additional income might easily push you into a higher tax bracket and create significant income tax liability for that year.

As a result of this potential tax liability, many of the beneficiary claim forms will ask you whether you want to withhold a percentage of the payout for payment of income tax. The financial institution may automatically determine the amount that is withheld, or it may allow you to specify how much to withhold. If you have the option of determining how much to withhold, you would be wise to seek the advice of an income tax professional to help you determine the appropriate amount.

Do Not Go It Alone

An article of this length cannot adequately cover all of the nuances of this important estate planning topic. Its aim, however, is to help you better understand the need to obtain sound financial, legal, and tax advice when claiming retirement plan benefits from a deceased loved one. There are numerous potential pitfalls that can easily be avoided with the help of a competent professional advisor. Do not hesitate to reach out to one when the need arises. We are available for in-person or virtual consultations, whichever is most convenient for you.

No Legal Advice Intended. This blog includes general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to contact a lawyer licensed in your jurisdiction for advice on specific legal issues or problems.