401k vs. taxable account - unmarried partners and long-term planning

[cheaplynn]

Ok, so my partner and I are not married nor do we have plans to be. This has no relation to the status of our relationship -- we are committed for the long term. Knowing that we don't plan to get "legally" married by the State, we have essentially arranged our own civil/private marriage in the form of estate planning. As of last weekend, we now have everything set up with wills, trusts, HIPAA, TODIs, etc. I'm feeling great; we're both going to be legally and financially protected in the case of the other's illness or death.

DP (male) is currently 52. I (female) am 40. We are both in excellent health.

Here's the situation that I'm currently working through: during the process of signing the estate planning paperwork, our lawyer made an offhand comment about rules governing non-spousal inheritance of a 401k. In short, if my partner dies, I would inherit his 401k but also have to fully withdraw all of the funds within 10 years. The concern here is the tax hit that I (or he) would incur if this happened. I've read that creating an "inherited IRA" might be a way to get around this, but --maybe?-- won't apply to me since I'm more than 10 years younger than him.

Right now, I don't have a 403b because my school district's options were always so terrible. They just switched providers, though, and I was planning to start a pre=tax savings account. Up until now, all of my retirement savings have been in a taxable index fund. My partner has a relatively small (at this point probably 30k) 401k -- he has been saving enough just to get his employer's 5% match. Pretty soon, thank GOD, we will have paid off a substantial amount of debt. I was hoping to max out his 401k starting next year, but now I'm wondering if that's the best plan. We max both of our Roth IRAs every year.

We are on track to retire in 8 years, when my partner hits 60. (Not super early for him, but kind of a miracle considering where he was financially 5 years ago.)  If we max out his 401k, he'd have at least 200k when he retires--more accounting for compounding growth and employer contributions. Should we just go for it because of the tax benefit? Or is the potential complication that it causes for me in the event of his potential early death too much of a risk? The other option is just to dump everything into a shared taxable account. It doesn't reap the pre-tax benefits, but there aren't any future stipulations on how to withdraw our money. Or am I overthinking things too much? We don't know when we're going to die, and while my partner is older than me, he is a lifelong runner and all of his health metrics put him at far younger than his actual age of 52.

Here's my question: other unmarried couples planning for retirement, how have you addressed this IRA/401k situation? I'm clearly muddled.
 

[seattlecyclone]

Aside from actually getting married I don't think there's a way to get around the ten-year clock for you emptying his retirement accounts if he dies first. The reverse isn't true: because he's not more than ten years younger than you, he'd be an "eligible designated beneficiary" who could use the old stretch rules on your accounts if you die first.

That said, inheriting a $200k IRA under the new rules doesn't strike me as being a major problem. That's $20k of income per year if you spread it out evenly, and you were probably planning to withdraw a portion of that $20k anyway. The thing to look at is whether the excess would push you into a higher tax bracket than he is currently in while working. If not, the retirement account seems like clearly the best choice. Even if it would, you have to weigh that cost against the relatively low risk of him passing away so soon after retirement.

If you let that account grow to a much higher value after retirement and he passes away at 80 or something, that becomes more of a big deal. Try to withdraw living expenses from his retirement account and/or do regular Roth conversions after retirement, just to keep the balance manageable.

[KungfuRabbit]

Like the previous poster said, you'd be looking at a max of $20k extra income per year (likely even less, because 401k distributions are a mix of income and capital gains, but for worst case scenario ill do the math at all income).  Given you are a teacher I'll guess your salary puts you in the 22% federal tax bracket, so adding this money on top would be taxed at 22% (but the capital gains will be taxed at lower, or even 0%, depending on your exact income and how much gains there were).

So, worst case scenario your pay $44k in taxes of the $200k inherited 401k. 

However, I'm confused by your alternate option.  If you don't use the 401k option now you pay those taxes anyhow, and maybe even more taxes if he is in a higher tax bracket.  So I see 3 scenarios:

1) invest in 401k, he doesn't die, you save a lot of money on taxes!
2) invest in 401k, he dies, you pay $44k in taxes
3) don't invest in 401k, it doesn't matter if he dies or not, you pay $44+k in taxes

So, aside from a little paperwork and complications, I don't see any downside at all to going the 401k route.  If you also are really worried about losing out on the $44k you could buy a small term life policy for him.  If its just a long enough term to get you to retirement age and a small value to just cover taxes and such it would likely only be like $20 / month (compared to the option of paying taxes now this would certainly be cheaper!).

[cheaplynn]

Thanks for the responses, seattlecyclone and KungfurRabbit. The way that you both lay out the scenario shows that I was indeed overthinking it and not really looking at how the math would work out. When I first heard this information from the lawyer, I immediately started playing out scenarios that were too extreme and not grounded in the reality of how much money is involved. I guess it just goes to show how much fear can cloud one's thinking when it comes to money.
So we'll carry forth then. I so appreciate your input on this. This community has been such a help when I've needed it. Thank you!!