A Better Deal When You Inherit a 401(k)

Making Your Money Last

A Better Deal When You Inherit a 401(k)

Instead of being hit with a big bill, heirs can now spread the taxes over a lifetime.

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.

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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.