Inherited 401K from sibling
August 29, 2013 10:36 AM   Subscribe

One of my siblings passed away unexpectedly a few weeks ago and I am one of the beneficiaries for her 401K. I would like some basic information on my options for handling the money. My share is not quite enough for me to pay a CFP (low $40K range) and I'd like to have some idea of where I stand before getting all the paperwork.

My understanding so far is as follows, and please correct me if you know otherwise:

1) I can let it sit, and there is a time limited period for how long I can do this.
2) I can roll it over to a new IRA of my own (but cannot combine it with my existing retirement funds).
3) If I withdraw the money, I owe income tax, but I do not owe a penalty.

What I am confused about:
How a rollover IRA works, when I could be required to take distributions, and whether I can still withdraw without a penalty from a rollover. I am in my mid-30s, so nowhere near the normal age to withdraw, and many of the scenarios online outlining required minimums are using examples much older. I do not have any immediate need for the money and do not want to take a large tax hit on it, but my sister would have wanted this to be used for the benefit of my kids, so it will likely be withdrawn before I retire. (I know that many financial professionals would likely argue against this.)
posted by anonymonkey to Work & Money (11 answers total) 2 users marked this as a favorite
I just went through this. The company which held the IRA walked me through the whole process and was enormously helpful. In fact, they had an entire department (and dedicated phone number) devoted to inherited IRAs. I could tell you my understanding of the situation, but wouldn't want to steer you wrong. Suggest you start with the company.
posted by Wordwoman at 10:40 AM on August 29, 2013 [2 favorites]

First of all, I'm sorry for your loss.

A Roll-Over IRA is easy to set up. Just call a brokerage: Fidelity, Vanguard, etc. Tell them you want to open a roll-over IRA and they'll take care of everything and send you something to sign. You can then invest the money into any fund or stock or instrument you like.

In an IRA, I believe you're required to take distributions in the 69 1/2 age range. But if you believe that you'll take early distributions, consider a Roth IRA. You'll pay the taxes on the money as though it were your income, but from there it will grow Tax Free, with no further taxes or penaties for withdrawl. (The Roth is tricky as it has limits and income caps, talk to the brokerage about it.)

Don't let it sit where it is though. Take it and do something with it.
posted by Ruthless Bunny at 10:41 AM on August 29, 2013

(My understanding is that you do not want a regular rollover IRA -- you want an inherited IRA account.)
posted by Wordwoman at 10:49 AM on August 29, 2013 [2 favorites]

Sorry for your loss...

I think a "rollover" will be into an inherited IRA account. If so one important thing to understand is the "life expectancy factor" for the account. In the normal case of your own IRA this is computed based upon your own age and the IRS tables. For an inherited IRA this can depend on the age of the person who passed away and/or the age of the person (or persons) inheriting the IRA. In the case of multiple non-spouse beneficiaries I think the life expectancy factor (for all parties) might be linked to the oldest beneficiary. So this is an important number to get right and to understand.

The life expectancy factor is important since it determines any required minimum distributions. Once you have the initial number the rest is easy since it decreases by one each year. Each year you must take distribution of that portion of the account (i.e. if the LFE was 40 you would need to take as a distribution 1/40 of the account balance as of Dec 31 of the previous year. The next year you would need to take 1/39 of the Dec 31 balance for this year, etc...) There is no penalty on this withdrawal...

Most firms will compute this for you (and do the automatic distribution) yearly...

Concerning taking the money out to pay for education - remember this money currently has a tax advantaged status and so has "special" long term tax benefits. If you keep this money until your retirement but use "other" money for your kids education which is not in an IRA I'm sure your sister would are still using her money, it's just coming out of another account.
posted by NoDef at 11:08 AM on August 29, 2013

My share is not quite enough for me to pay a CFP

Sure it is. A CFP doesn't have to be an ongoing monthly expense. You can pay them a couple hundred bucks to get you set up and send you on your merry way. It's worth doing that just to avoid getting nailed on various tax issues that you could otherwise completely avoid.
posted by valkyryn at 11:09 AM on August 29, 2013

Thanks. Her account is with one of the large brokerages and I'm the oldest beneficiary (my sister was younger as well), though I was told over the phone it would be split.

And yes, inherited is the term I meant. (in the back of my mind, I knew rollover wasn't right.)

I was getting confused as a result of too much Googling, I think. I'm slightly overwhelmed by it all.
posted by anonymonkey at 11:28 AM on August 29, 2013

It's okay to take a deep breath and do nothing for a while. It is overwhelming, and the money is all tied up in the understandably painful emotions of losing a sibling. So, big picture, is your main goal to minimize the tax paid while using the money before retirement age? A fee-only financial planner can definitely help you with that, and probably for only a few hundred dollars. Depending on your tax bracket, AMT, etc., you could easily cost yourself far more than a few hundred bucks if you withdrew it unwisely. The planner can also advise you about where to invest the account in the meantime based on when you think you'll use the money.

On the big picture side, though, may I suggest that part of treating your kids well is being able to take care of yourself in retirement? They can borrow for school, you can't borrow for old age. If you did need help, it would likely be at the same time as they are raising kids and saving for college, making it difficult on everyone. Taking a very crude model of retirement savings (none of this is financial advice, your mileage may vary, past performance does not predict the future, etc.), you can withdraw, indefinitely, about 4% of your nest egg annually. Assuming your salary and living expenses stay about the same over time, that means at the time of retirement you need 25x your current salary to replace your current income. Social Security will cover some of that, so maybe you need 20x in investments.

Let's say you start at age 21 with nothing saved and put away 10% of your income (including employer match) annually. Assume a constant, after-inflation return of 7% (which is probably generous). 40 years later you'll have just about 20x your salary saved. To get there, though, by 35 you should already have socked away 2.5 times your salary. That is, if you're making 60K, you should have $150K in your 401(k) right now. (For those who are curious, the numbers are: age 25-.6X, 30-1.4X, 35-2.5X, 40-4.1X, 45-6.3X, 50-9.4X, 55-13.8X, 60-20X) Again, do not take this as gospel; it's just a rough calculation that you could run yourself, but I highly recommend seeing a fee-only professional to make sure you're on track. It's hard to know your big picture goals unless you know where you stand.
posted by wnissen at 11:52 AM on August 29, 2013 [1 favorite]

What do you do for your own retirement savings? If you're determined to use this for your kids you have two options that I can see.

One, there's provisions in the tax code for withdraw for college purposes without paying the additional 10% penalty. You'll still pay income tax on this money but there seems to be no way to dodge this on inherited 401(k)s anyway. Normal inheritances don't get taxed as income but since a 401k dodged the taxation initially the govt hits you up for it.

So you do the inherited IRA route and dip into the money later, knowing that you're using money you wouldn't have had in that account otherwise.

Two, simply divert money from your normal retirement savings over the next five years into college savings instead. If you want to justify this you can convince yourself that 40k now, assuming you save a full 8k/yr, is actually better than that money saved over the next 5 years. After all, it starts working immediately rather than the deposits you'd make 1-4 years from now. Divert those payments instead into some sort of college savings.

In the best possible world, in my opinion, you simply supplement your retirement savings with this and you allow yourself better future prospects to help your kids because you're less worried about retirement savings. But I don't know your financial situation. I think you'd be well served spending a few hundred bucks on a planner and/or a CPA to make the best possible choice.
posted by phearlez at 1:08 PM on August 29, 2013

Schwab has a pretty good if-then sort of walkthrough on your choices, by the way. Better than some of the higher-ranked google returns.
posted by phearlez at 1:37 PM on August 29, 2013

required minimum distributions over your lifetime as determined by IRS tables. roll it into a brokerage like vanguard and invest in ETFs or some low cost investment vehicle. 401ks usually have higher fees, so you'll want to get it out of there.

I don't think there are early distribution penalties, but remember that you need to treat it separately from.your other retirement accounts (ie, don't make contributions to it)
posted by jpe at 4:51 PM on August 29, 2013

I'm very sorry for your loss, I can't imagine how difficult everything must be for you right now. Seriously, pay for a CFP. It'll be worth the money to not have to do the research/paperwork on your own, plus they'll keep you from messing up and paying more in taxes/penalties than you have to. (Side note: required minimum distributions aren't required until age 70 1/2 - but i"m not sure if Beneficiary IRAs use your age or the deceased's age. And generally, 401ks can only be turned into traditional (not Roth) IRAs). A CFP would know all these answers for you, and be more than willing to walk you through.
posted by csox at 7:33 AM on August 30, 2013

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