Many people are surprised to learn that an IRA or 401(k) can come with a tax bill for the person who inherits it. Knowing the basics now can help you pass on more of what you intended, and avoid confusion for your family.
- Retirement accounts go to the people named on the account form
- Heirs generally pay income tax on pre-tax money they withdraw
- Rules on how fast the account must be emptied depend on who inherits it
- Review your beneficiaries after any major life change
Your beneficiary form comes first
A retirement account does not follow your will. It goes to the person named on the account's beneficiary form. If the form is out of date, the money can go to a former spouse or to someone you no longer have in mind. If no one is named, the account may go to your estate, which can mean extra delay and different tax treatment.
Name a primary beneficiary and a backup, and check the forms every few years.
How heirs are taxed
Money in a traditional IRA or 401(k) has not been taxed yet. When an heir takes it out, the amount is generally added to their income for that year. A Roth account is different. Qualified withdrawals are generally tax-free, though the account still has rules about timing.
The timing rules
How long an heir has to take the money out depends on who they are:
- A spouse usually has the most choices, including treating the account as their own.
- Certain other heirs, such as a minor child, a disabled or chronically ill person, or someone not much younger than you, have different rules.
- Most other heirs, such as adult children, are generally required to empty the account within a set number of years under current law.
These rules have changed in recent years, and they can depend on whether the original owner had already started required withdrawals. Check the current IRS guidance or ask a professional.
Why the tax bracket of the heir matters
An adult child in their peak earning years may pay a higher tax rate on an inherited IRA than you would have paid yourself. Some families look at this when deciding which accounts to spend first, and which to leave behind. Others look at Roth conversions during their own lifetime as a way to shift the tax bill. Each has trade-offs.
Using a trust as a beneficiary
Some people name a trust to manage how an heir receives the money. This can add control, but it also adds complexity and special tax rules. An estate attorney can explain whether it fits.
- Beneficiary named on every retirement account
- A backup beneficiary named
- Forms reviewed after marriage, divorce, birth or death
- A list of accounts shared with a trusted person
- Your attorney and tax professional know about each other
How you leave retirement money can matter as much as how much you leave. If you would like to look at the tax side of your legacy, let's talk.
Book a consultationSources and references
This article is general information, not legal, tax or investment advice for your situation. Inheritance rules change and depend on your facts. Talk with a qualified attorney and tax professional before making decisions.
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