Author Topic: 401K Inheritence and Estate Planning  (Read 3516 times)

Blackbeard

  • 5 O'Clock Shadow
  • *
  • Posts: 52
401K Inheritence and Estate Planning
« on: November 11, 2016, 04:23:22 PM »
Hello
After a long battle with cancer my mom was diagnosed with terminal cancer, she is stage 4.  She's led a full life and is in great spirits.  With that said she asked me to help prepare her will/plan her estate. 

She has two large assets an -$800,000-1,000,000 401k and a house fully paid for worth about $200,000.  I have an older sister that will be splitting the 401k 50/50 with me and receiving the entire house.  My dad passed away about a year ago so her and I are the only heirs.

What I need to understand is how to best manage this from a tax perspective and also for my mom.  I've got no problem reaching out to a lawyer but I'd like to do some research first.  Does anyone have a website or book that they could recommend or first hand experience.  I'm sure this is not an uncommon situation with the prevalence of 401ks.

Thanks for any thoughts.

On a side note!  While I am upset, we've mentally prepared, hope for the best and such, I was shocked when she told me the amount of money they had in their 401k!  My parents were/are great people.  He was a blue collar worker and she was a stay at home mom.  We had a very rich childhood.  I would never have said we were rich and they never ever talked about money with us.  They made us pay for college.  But the day we graduated we both got checks for our tuition and swore to never tell the other what happened for our tuition, room and board was on us, too much partying.  We both graduated with engineering degrees in 6 semesters because we didn't want to pay more!  He retired because of health issues when he was 55 lived until he was 72.  For the past 10 years I was offering to support them help them with cash and they never said a word.  They just politely said they were okay.  Baby Boomers! 

Their story is a reaffirmation of the save and spend wisely theory of mustachians.  A) he probably never made more than $40-45,000 per year.  B) they never lived above their means or even at their means.  C) They never pulled a dollar out of their 401k he had a pension they lived off of and then social security.  D) She invests 50% of her social security checks back because her cost of living is so cheap.  E) I never knew!!!

pbkmaine

  • Walrus Stache
  • *******
  • Posts: 8296
  • Age: 62
  • Location: The Villages, Florida
Re: 401K Inheritence and Estate Planning
« Reply #1 on: November 11, 2016, 04:36:02 PM »
No federal estate tax if it is under $5.490 million in 2017. State tax varies by state. Please make sure her beneficiary designations are correct before she passes. Retirement accounts like 401(k)s as well as insurance policies are not controlled by the will, but by beneficiary designations. It does not matter what she "wants". It's what the document says.

The IRS website, irs.gov, has excellent information.

Frankies Girl

  • Magnum Stache
  • ******
  • Posts: 2955
  • Age: 81
  • Location: The laboratory
  • Typical Ghoul Next Door
Re: 401K Inheritence and Estate Planning
« Reply #2 on: November 11, 2016, 05:19:20 PM »
I am so sorry about your mom. That is wonderful that even in this time, she's thinking of those she loves and trying to make it as easy as possible on you and your sibling.

I lost my dad a few years back, and there were several accounts (401k, IRAs, life insurance policies) and a small house (our childhood home). I have one sibling and he split everything 50/50 in the will.

Whomever is named executor/trix should be moderately comfortable dealing with money and paperwork. And if there is the possibility of animosity between siblings, an outside person might be best so one is not seen to be favored above the other. But if you are taking it on, I might want to say please consider not taking the executor's fee from the estate as a gift to your sibling since it would be unbalancing the "equal" division. But if you feel it is going to be a huge amount of work, then that is what the fee is for... I just point this out because if you have the least little bit of difficulties with your sibling, it would be so sad for the fee to cause more problems and it may not be worth it.

We had dad's tax guy/attorney as a guide through all of this, and he advised us on any legalities and the steps involved for our state. Definitely recommend finding one that is reasonable as he was invaluable for us - including filing the final both our father's taxes for his last year and the estate taxes (it drug out over 2 years) and making sure to get the forms needed to us after closing the estate.

One thing that really helped was that on several of his investment/retirement accounts, dad named us as Transfer On Death beneficiaries. Also known as TOD, you can put in any percentage. I believe they even allowed "per stipes" which means in the event that one beneficiary has passed, their children will still inherit their parent's share (only important if either of you have children obviously).

Anything labeled TOD or with beneficiaries, means it passes outside of probate (but may not avoid state estate taxes if your state has them). This designation trumps anything in a will, which means also that even if she wants to leave 100K to a charity or whatever, if she's named you and sister as TOD beneficiaries on her investments, that will bequest will need to come from the estate - cash/bank account with no beneficiary named or funds from after the property is sold if not specifically named "I leave the house to my son and daughter" type of thing - but that is why you need an attorney to write a will correctly. So she should be aware that any gifts to other relatives or charity need real money/property sold to back that up otherwise it might not be fulfilled.

She may want to make all of her charitable donations now while she is still alive and just leave a simple will - you and your sister as 50/50 heirs, all property to be split between you, and any investment accounts that can have named beneficiaries, do so. This would probably be the easiest for you and your sister as long as you get along well.

Again, something to discuss with an estate planning professional - how to ensure the stuff she wants gets done in her will.

For the investment/retirement beneficiary designations, that money is released to you and your sister as soon as you satisfy their requirements and is not required to go to probate. The financial institutions will walk you through the steps involved, and you should make sure to let them know this applies to you and your sibling (she will need to contact them after the fact as well, but most of the time did not need to send additional death certificates - they should assign you a contact that can match you both up with your parent's accounts and advise you both how to proceed with setting up your inherited accounts). But basically you'll call up each one and get them to tell you what they want from you.

Fido allows you to set beneficiaries online, and I'm pretty sure most other places allow this as well, but first setup would be to contact the financial institutions and ask if you are unsure.

Same for any life insurance policy. My dad's had a feature that allowed the funeral home to take their expenses directly from the policy and then cut us a check for the remainder (as sister and I were equal beneficiaries, we received a check for half of the remainder and it was already calculated on there how much in taxes we'd owe for the interest earned for the time between his death and the final payout).

The property went through probate, and you definitely should make sure that happens. You and sister can declare a set value on the contents (furniture, antiques, books, clothes, vehicle...) instead of having to have someone come in and value it for a price and take ages to do so - at least that was an option we were given, and we chose to do so to save time and anguish going through everything (but we also were dealing with a hoarder, so that would have been awful). Unless your mom specifies items in her will for certain people, that would mean you and your sister would just pick things you want and agree how to deal with the rest on your own (and can give away items for her as long as she leaves you a list? Seems easier if you all get along, but if not, then she'll need to name things in her will so there is no misinterpreting).

As far as the house you really want to make sure it goes through probate since by inheriting, you get to reset the value at the time of your mother's death - it is called "stepped up cost." So that means that if she paid $50K for the house back in 1980, and it is now worth 200K, if she gave you the house before death, you would have to pay taxes on the increased value of $150K (split between siblings if sold and you're equal partners). But with inheriting it through the magic of stepped up cost, you take the current house value on the date she dies (can use property tax records or have a realtor evaluation - we used prop tax records ourselves for the year he died). Therefore if you sold it and got $220K, you'd only have to split the extra 20K for your taxes. And if you sold it for 180K, then you'd get to write off a loss on your taxes of 20K... so it's VERY important to check with a lawyer to make sure this happens correctly... the difference can be painful if the house has appreciated quite a bit since purchased and that would suck to get hit with a several thousand tax bill because it wasn't properly setup through inheritance.

The accountant (if you have one and I do recommend it for the estate anyway if not for your mother's final tax bill) can be paid out of the estate. They will send you and your sister any and all forms and tax statements necessary (things like 1099-INT, 1099-DIV and K-1 forms).


kite

  • Pencil Stache
  • ****
  • Posts: 589
Re: 401K Inheritence and Estate Planning
« Reply #3 on: November 12, 2016, 03:42:14 AM »
No federal estate tax if it is under $5.490 million in 2017. State tax varies by state. Please make sure her beneficiary designations are correct before she passes. Retirement accounts like 401(k)s as well as insurance policies are not controlled by the will, but by beneficiary designations. It does not matter what she "wants". It's what the document says.

The IRS website, irs.gov, has excellent information.

THIS!  THIS!  THIS!

Check the beneficiary on 401k.  That's who gets it.  Beneficiaries can be changed if necessary.  But how quickly depends on where the 401k is held.
And call the lawyer yesterday.  If she's stage 4, there is no time to waste.  If there is no will now, she may very well die intestate and her non-401k assets will pass to heirs according to the laws of your state.  After the lawyer helps your family square away your Mom's estate, get your own Will, Advanced Directive and PoA drawn up. 

Sorry about your Mom. 
« Last Edit: November 12, 2016, 07:34:18 AM by kite »

Blackbeard

  • 5 O'Clock Shadow
  • *
  • Posts: 52
Re: 401K Inheritence and Estate Planning
« Reply #4 on: November 12, 2016, 06:21:55 AM »
Thank you so much for all of the great advice.   Monday I'll contact a lawyer and check the beneficiaries on her accounts.

A general question.  What happens to the 401k as it passes to us?  Would it then be like a second 401k that I can roll into my own tax free (other than state estate taxes)?  My sister is flat broke, hence her getting the house.  Im afraid she would just cash her portion out.  So I'm assuming she'd get the 10% penalty and then normal taxes on top if she just cashed it, correct?

Thanks again.

Catbert

  • Handlebar Stache
  • *****
  • Posts: 1686
  • Location: Southern California
Re: 401K Inheritence and Estate Planning
« Reply #5 on: November 12, 2016, 10:37:46 AM »
Aggrah.  I could answer the question if it were an IRA rather than a 401k.  Guessing that it would work the same doesn't really help you. 

Regarding the house, check to see if your state allows Transfer on Death for real estate.  Most don't but a few do.  If you're one of those state your mother can file a form to TOD the property to your sister.

wintertell

  • Pencil Stache
  • ****
  • Posts: 520
  • Age: 30
Re: 401K Inheritence and Estate Planning
« Reply #6 on: November 12, 2016, 06:33:20 PM »
We inherited a 401(k).

For us, there was an option to cash it out, take payouts over 5 years or roll it over to a inherited tIRA. Inherited tIRAs are subject to required  minimum distributions depending on the deceased's age and your age.

You can split and do something different than your sister. They go by the asset allocation that is in the beneficiary paperwork.

tIRAs are taxed upon withdrawal, so it is advantageous to roll it over and take out only the RMD or as little money as you need and let the rest continue to grow tax free.

For the 401(k), all that was needed was a copy of the beneficiary paperwork and the death certificate. We then opened up an inherited IRA account with Vanguard. We also had to fill out paperwork with the 401(k) holder who was in charge of the transfer.

Only the amount taken of the 401(k) is taxed as income.

It is not subject to estate tax, but it is subject to inheritance tax if your state has it.

We had to get the paperwork done within 30 days or they would have chosen to just pay it out. Each 401(k) plan is different, so you have to call the 401(k) plan holder to see what your options are.

Lastly, please do this all ASAP. In our case, the paperwork was halfway done and it left a huge mess that just made the loss and grief worse.
« Last Edit: November 12, 2016, 09:29:13 PM by wintertell »

Frankies Girl

  • Magnum Stache
  • ******
  • Posts: 2955
  • Age: 81
  • Location: The laboratory
  • Typical Ghoul Next Door
Re: 401K Inheritence and Estate Planning
« Reply #7 on: November 12, 2016, 09:11:16 PM »
Inherited 401k/IRAs are a different animal all together.

No, you can not treat it as your IRA - no adding to it, no rolling it or merging it into any existing IRAs unless your parent leaves you more than one IRA, in which case you can merge those IRAs. And if it is a inherited 401k, you can (and should) convert it to an inherited IRA so you have better investing options and no fees (I believe you must roll a 401k into a IRA after the death of the parent but you will need to confirm).

It will become an inherited IRA Beneficiary Distribution Account (BDA) account, likely with your parent's name attached.

The only time you could treat an inherited IRA as your own is if it was a spouse that left it to you.

You have two choices as a non-spouse on how to set this up:

1. You can choose to take distributions over you life expectancy, known as the "stretch IRA option," which leaves the funds in the IRA for as long as possible. Most of the larger financial institutions will help you set up auto RMDs that calculate the amount you'll need to take, let you set the day to distribute, and withhold whatever you want for federal and state taxes automatically. It is super easy and this is the smartest move all the way round. And you can always take more out if you'd like, but again, you'll need to figure in a bit of money on the side for extra taxes (or increase your W2 so it covers).
   
2. You must liquidate the account within 5 years of the original owner's death. Very bad idea if it is a larger account because you will owe taxes on this amount just like you earned it (it counts just like regular income) so it could mean you'd get hit with a HUGE tax bill in any year you took a large distribution, especially if you're also actually working and drawing earned income.

BIG RED FLASHING NEON WARNING: In order to do the stretch IRA version, you have to take out your first distribution in the next calendar year by Dec. 31 of the calendar year following the year that the decedent died. If you miss that date, you default back to the 5-year rule. And owe lots of taxes too. AND you also need to make sure that in the year your parent passes, if it is near the end of the year, that the parent took their distribution before December 31 of that year if they were of the age to be required to take them (70 or older). So this needs to be addressed ASAP.

My father died in December so his accountant (lawyer) immediately checked into whether he'd taken the distribution as he was also over 70 years old, because if not, the the executor would need to do so before the 31st and add the funds to the estate. Fortunately he had taken it early in the year, so we just had to worry about getting the account split between my sister and I and got the automatic distribution set up before the end of the following year.

There is no 10% penalty on any withdrawal or distributions from an inherited IRA. This is a surprising benefit - and one that means you have a tax deferred vehicle that you can pull money from any time.

BUT - the money will be subject to taxes at the same rate as regular income. So any distribution probably should have some taxes withheld up front (this is really easy to set up in your required minimum distributions). I started out withholding 20% federal and just recently figured out my tax situation and changed it online. Super simple to do.
« Last Edit: November 12, 2016, 10:07:40 PM by Frankies Girl »

wintertell

  • Pencil Stache
  • ****
  • Posts: 520
  • Age: 30
Re: 401K Inheritence and Estate Planning
« Reply #8 on: November 12, 2016, 09:31:59 PM »
BUT - the money will be subject to taxes at a different rate than regular income. So any distribution probably should have some taxes withheld up front (this is really easy to set up in your required minimum distributions). I started out withholding 20% federal and just recently figured out my tax situation and changed it online. Super simple to do.

Why is the money subject to taxes at a different rate than your regular income?? What is the different rate? My impression was that it just added to your total income for the year.

Frankies Girl

  • Magnum Stache
  • ******
  • Posts: 2955
  • Age: 81
  • Location: The laboratory
  • Typical Ghoul Next Door
Re: 401K Inheritence and Estate Planning
« Reply #9 on: November 12, 2016, 10:06:42 PM »
BUT - the money will be subject to taxes at a different rate than regular income. So any distribution probably should have some taxes withheld up front (this is really easy to set up in your required minimum distributions). I started out withholding 20% federal and just recently figured out my tax situation and changed it online. Super simple to do.

Why is the money subject to taxes at a different rate than your regular income?? What is the different rate? My impression was that it just added to your total income for the year.

Crap. Fixed that. Got muddled during the data dump.

pbkmaine

  • Walrus Stache
  • *******
  • Posts: 8296
  • Age: 62
  • Location: The Villages, Florida

Blackbeard

  • 5 O'Clock Shadow
  • *
  • Posts: 52
Re: 401K Inheritence and Estate Planning
« Reply #11 on: November 13, 2016, 08:59:34 AM »
I can't thank you guys enough for all of the help.  I have got a lot of thinking to do.  It's weird I am was at peace with her eventual passing, but I never expected her to have this money so I'm conflicted with some selfish thoughts. 

If I read the above right and I still have lots of searching I have two options.  Take five year distributions $80k/yr and pay tax on it OR but it in to a special IRA which I can pull anytime without the 10% penalty. 

So did my mom just give me the ultimate "Roth Pipeline"?  We are about 3 years away from FIRE without this money.  I've got some contractual obligations so that timeframe is set.  Essentially I could FIRE on their money and continue letting my stash grow. 

Am I thinking about that right?

wintertell

  • Pencil Stache
  • ****
  • Posts: 520
  • Age: 30
Re: 401K Inheritence and Estate Planning
« Reply #12 on: November 13, 2016, 09:10:01 AM »
So did my mom just give me the ultimate "Roth Pipeline"?  We are about 3 years away from FIRE without this money.  I've got some contractual obligations so that timeframe is set.  Essentially I could FIRE on their money and continue letting my stash grow. 

Am I thinking about that right?

Yes, if the plan rules allow for it, you can roll it over to an inherited IRA. You are required to take out minimum distributions. But you can take out more at any time with no penalty. This is essentially equivalent to the backdoor Roth ladders that folks create, except you would have to pay taxes on the withdrawals.

Whether it is 1 time or 5 years or the extended distribution all depends on the plan's rules AND, as Frankies Girl says, making sure the RMD is pulled out before the end of the year if required by your mom's age.

Just gotta to make sure the paperwork is in order ASAP. Like I said, in our case, things deteriorated rapidly and our loved one was unable to take care of the paperwork needed to make sure everything transferred easily.

gatortator

  • Stubble
  • **
  • Posts: 134
Re: 401K Inheritence and Estate Planning
« Reply #13 on: November 14, 2016, 07:09:04 PM »
following as I will eventually be in this situation (executor with an inherited IRA)

So did my mom just give me the ultimate "Roth Pipeline"?  We are about 3 years away from FIRE without this money.  I've got some contractual obligations so that timeframe is set.  Essentially I could FIRE on their money and continue letting my stash grow. 

to my understanding, based on this https://www.law.cornell.edu/cfr/text/26/1.408A-4,  the RMD can not act as a roth pipeline conversion.

Quote
(c) If a required minimum distribution is contributed to a Roth IRA, it is treated as having been distributed, subject to the normal rules under section 408(d)(1) and (2), and then contributed as a regular contribution to a Roth IRA. The amount of the required minimum distribution is not a conversion contribution.

wintertell

  • Pencil Stache
  • ****
  • Posts: 520
  • Age: 30
Re: 401K Inheritence and Estate Planning
« Reply #14 on: November 14, 2016, 07:29:04 PM »
It is not a Roth IRA pipeline. It is a completely instrument though, in the fact that it is pre-tax money, so it raises your annual income, and its requires you to pull out minimum distributions.

But effectively, it acts the same way because you have a big pot of money where you can withdraw unlimited amounts (as long as they are above the RMD) with no tax penalty for pulling it out before age 59 1/2.  That is the basic purpose of making a Roth ladder, IMO.