Starting this year, if you inherit a 401(k) or other qualified company retirement plan from someone other than your husband or wife, you may be able to transfer the balance directly to an IRA. And that's a really big deal.
The new rule gives you a valuable opportunity to stretch your distributions -- and the tax bite -- over your lifetime while the investments continue to grow tax-deferred. Previously, only spouses could roll over an inherited company plan to an IRA. Everyone else usually ended up taking distributions in a lump sum or over a few years -- and paying substantial federal and state taxes just as quickly.
To get the full benefit, it's important for children, grandchildren, siblings and other named beneficiaries to follow the rules exactly, says IRA expert Ed Slott, a CPA in Rockville Centre, N.Y. That means you must transfer the money directly into a properly titled inherited IRA that's maintained in the name of the deceased -- for example, "John Smith's IRA (deceased Jan. 1, 2007) for the benefit of Mary Jones, daughter."
Trying to roll the inherited money into your own IRA or cashing a distribution check made out to you could mean big trouble because you'd owe taxes on the entire amount. So watch out, warns Slott. A company isn't required to transfer the money automatically to an inherited IRA. If it insists on issuing a check, make sure the check is made out directly to the inherited IRA and not to you.