Author Topic: I'm Lost: What Should I Do With My Inherited 401k?  (Read 1902 times)

Frida Stache

  • 5 O'Clock Shadow
  • *
  • Posts: 2
I'm Lost: What Should I Do With My Inherited 401k?
« on: November 23, 2016, 01:08:59 PM »
My husband and I discovered MMM about six months ago and we have made some major life changes, so that's a plus. Still, we've got a long way to go. It's my first time writing in the forums, and unfortunately it's under sad circumstances.

My aunt passed away suddenly five years ago, and I inherited part of her 401k. Over the past 5 years, it grew to $35,000. Just recently I got a call that I would need to withdraw the money by December 31. I didn't do my "homework," so to speak, when I inherited the 401k (partly out of shock of what happened to my aunt and partly because I hadn't seen the MMM light), so now I am trying to wrap my head around my options.

I've called the company's retirement services number several times to get some clarifications, and they've said that I'll need to withdraw the lump sum and they will withhold 20% for taxes. The last time I called, however, a representative said that they could actually roll all of it into an inherited IRA for me, and then I would just have to start taking the required minimum distribution each year (so this would be the "life expectancy stretch method," if I have that right). The catch, he said, is that if I am audited I would have to pay penalty fees for not taking my RMD in the four prior years.

So my question is: Is it better to take the lump sum with the 20% taxes now, so I don't have to worry about the penalty fee potential? Or is the penalty fee (if I do get audited) not that big of a deal, considering the long term benefits of rolling over to an inherited IRA? I'd love to know any thoughts as I am sufficiently confused after my last call.

Here's a bit more about me:
Age: 32
Salary: 66,000
Assets:
401k: 30,000
Inherited 401k: 35,000
Roth IRA: 6,000 (I have not contributed anything to this account this year)
Liabilities:
44,000 student loan at 4% interest (this is after refinancing)
*I have no other debts
(My husband makes 95,000 and this year we each put 15% of our salaries into our 401ks.)

*Before I knew about the inherited ira roll-over option, my plan with the lump sum was to put 5,500 into my roth, bump up my 401k contributions for the end of the year, and put the rest toward my student loan.

chasesfish

  • Magnum Stache
  • ******
  • Posts: 3023
  • Age: 37
  • Location: Texas
    • Years in the making, I created a journal!
Re: I'm Lost: What Should I Do With My Inherited 401k?
« Reply #1 on: November 23, 2016, 01:43:13 PM »
I think you have two nearly equal options:

Take the distribution and pay the taxes.  I don't believe you also pay a penalty, so it'll just be an increase in your taxable income and move on.

The second option is hire a CPA and run though this scenario on the stretch.  You'll probably want to self-report the error to the IRS and settle on whatever taxes/penalties you owe to do the stretch.   I think the accounting fees/help make this option more expensive than its worth. 

If there's a tax accountant on this board, they may be more helpful.

Frida Stache

  • 5 O'Clock Shadow
  • *
  • Posts: 2
Re: I'm Lost: What Should I Do With My Inherited 401k?
« Reply #2 on: November 23, 2016, 05:31:38 PM »
This is really helpful—thank you. I was leery of rolling it over to the stretch, without self-reporting the error, and I do agree that accounting fees make it more expensive than it's worth. Pretty sure the lump sum is the way to go, at this point.

RetireeInTraining

  • 5 O'Clock Shadow
  • *
  • Posts: 7
Re: I'm Lost: What Should I Do With My Inherited 401k?
« Reply #3 on: November 24, 2016, 12:53:37 PM »
Interesting conundrum -- something similar is happening to my DW right now.

Anyone else have any thoughts??

seattlecyclone

  • Magnum Stache
  • ******
  • Posts: 4803
  • Age: 34
  • Location: Seattle, WA
Re: I'm Lost: What Should I Do With My Inherited 401k?
« Reply #4 on: November 24, 2016, 01:25:07 PM »
I believe the penalty for failing to take an RMD is 50% of the RMD. That's a pretty hefty price to pay to stretch out the IRA payments over more years. You'll have to run some numbers, but taking the lump sum and reinvesting it in a post-tax account may be the best option available at this point.