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New pension rules help 401(K) beneficiaries

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POSTED: May 5, 2007 5:02 a.m.
As you’re probably aware, the traditional pension plan has not fared so well in recent years. In fact, many large companies have frozen or discontinued their plans.
Congress passed laws last year to strengthen pensions, but some other provisions of this legislation may interest you even if you don’t have a pension, especially if you may be coming into an inheritance that includes a 401(K).
A 401(K) can be a sizable bequest. By the time many people retire, their 401(K) or other employer-sponsored retirement plan — such as a 403(B) or 457(B) — may be their biggest single financial asset.
Even if they died before depleting the funds in their 401(K) or other plan, they might still have a large chunk of money to pass on. It’s never been much of a problem to leave this money to a spouse, who could roll the funds into an IRA. Once the money was in this IRA, the surviving spouse could continue enjoying the benefits of tax-deferred growth.
However, non-spouse beneficiaries — such as children, grandchildren, siblings and domestic partners — did not have this luxury. When these beneficiaries inherited a 401(K) or other retirement plan, they were generally forced to take the entire balance within five years of the account owner’s death — and some plans required them to take the payout as a lump sum within one year.
These accelerated payments were likely to create what is euphemistically called a “taxable event.” In plain English, this means that if you were a non-spouse beneficiary, you were likely to take a big tax hit after you inherited the 401(K) or other retirement plan.
Now, however, things have changed, thanks to the new pension laws.
Effective Jan. 1 of this year, if you are a non-spouse beneficiary, you can transfer an inherited 401(K) or other retirement plan into an IRA. And that means you can “stretch out” distributions and taxes over your lifetime, rather than being forced to take withdrawals immediately or over a period of a few years.
By stretching this inherited account, you can continue to enjoy tax-deferred growth, which can create a significantly greater amount of income over your lifetime.
Clearly, this can be a huge advantage to you. But you need to make sure you’re following the correct procedure.
In “legalese,” you have to make what’s known as a trustee-to-trustee transfer by establishing an “inherited” IRA and have the check from the 401(K) or other plan made payable to the trustee or custodian of this IRA. Once this account is established, you can’t contribute anything more to it or roll the money into any other IRA you might have.
Your financial advisor can help you set up the inherited IRA and invest the distributions from the 401(K) or other plan to help you meet your financial goals in a way that is appropriate for your individual risk tolerance. You may also want to consult with your tax advisor before transferring funds from the retirement plan to the IRA.
In any case, once you learn you are going to inherit a 401(K) or other retirement plan, start doing your homework right away. If managed correctly, this type of inheritance can make a big difference in your life so make the most of your opportunity.

Cardella is a financial consultant with Edwards Jones in Hinesville
 

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