Author Topic: minimizing taxes on 401k inheritance  (Read 7876 times)

Abe

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minimizing taxes on 401k inheritance
« on: November 18, 2013, 07:22:43 PM »
Hello all, my parents are approaching retirement age soon. They have a good pension, will work part-time for a while, and will likely not need their 401k savings. When they reach the age for required minimum distributions, what is the best way to minimize tax losses? They will be in the 25% marginal tax bracket. My understanding is that if I were to inherent the 401k, it would be taxed as income in my tax bracket (35%)? In this scenario, would it be better for them to withdraw the 401k, pay the marginal income tax at 25%, and give the cash as inheritance? Is there a way to transfer the inheritance to grand-children with lower tax burden?  Thank you for recommendations.

alanwbaker

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Re: minimizing taxes on 401k inheritance
« Reply #1 on: November 18, 2013, 10:37:20 PM »
Hello all, my parents are approaching retirement age soon. They have a good pension, will work part-time for a while, and will likely not need their 401k savings. When they reach the age for required minimum distributions, what is the best way to minimize tax losses? They will be in the 25% marginal tax bracket. My understanding is that if I were to inherent the 401k, it would be taxed as income in my tax bracket (35%)? In this scenario, would it be better for them to withdraw the 401k, pay the marginal income tax at 25%, and give the cash as inheritance? Is there a way to transfer the inheritance to grand-children with lower tax burden?  Thank you for recommendations.

Abe, you understand it correctly.  If their 401K balance is substantial, they may want to take distributions earlier than 70.5 and at a higher rate than the RMD so that the 401K doesn't outlive them.

Inheritance taxes are subject to the vagaries of future politicians.  Do your parents have sufficient income and investments for a comfortable retirement?  If so, giving to children and grandchildren while they are alive is a good plan.  If done right it's much more rewarding than giving it to them when you're dead!  Currently they can give $13K a year per person with no tax effect.  Of course this begs further questions about their longevity and financial situation.

And there are other ways to help children & grandchildren.  These are focused on education, which is usually an excellent investment.  529 college plans are useful but they vary widely.  Your parents can also directly pay for educational expenses without tax consequenses.

Hope this provides some food for thought.

seattlecyclone

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Re: minimizing taxes on 401k inheritance
« Reply #2 on: November 19, 2013, 02:57:52 PM »
One thing they may want to consider is rolling over the 401(k) to a Roth IRA over a period of several years. They would calculate how much room they have left in the 25% tax bracket and roll that amount over to the Roth each year. They could even consider using up the 28% bracket as well, since 28% isn't that much more than 25%.

The advantage of doing this is twofold. First, there are no required minimum distributions from a Roth IRA as long as your parents are alive. Once the balance is rolled over, they can withdraw from the account if they want, or just let the account keep growing tax-free until they need the funds. Secondly, you can leave a Roth IRA account to your heirs, and they will also enjoy tax-free growth out of that account. One thing to note is that heirs do have required minimum distributions out of an inherited Roth IRA, so the heirs can't leave the money in there forever, but they also won't have to pay their current marginal tax rate on any distributions from that account.

Furthermore, if your parents have enough assets for the estate tax to potentially come into play, paying the taxes on this 401(k) money during their lifetime (instead of letting their heirs do it) should reduce the size of the estate and thus reduce the amount of estate taxes owed.

Undecided

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Re: minimizing taxes on 401k inheritance
« Reply #3 on: November 19, 2013, 03:39:11 PM »
Currently they can give $13K a year per person with no tax effect. 

They can also gift (while living) up to the current amount excluded from federal estate tax (albeit at the cost of decreasing the availability of that exclusion at death), without paying federal gift tax.

Spork

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Re: minimizing taxes on 401k inheritance
« Reply #4 on: November 19, 2013, 03:47:37 PM »
Currently they can give $13K a year per person with no tax effect. 

They can also gift (while living) up to the current amount excluded from federal estate tax (albeit at the cost of decreasing the availability of that exclusion at death), without paying federal gift tax.

... and this $13k is PER PERSON.

In other words (assuming all parties are living and receiver is married)
Mom gives Son $13k
Mom gives Son's wife $13k
Dad gives Son $13k
Dad gives Son's wife 13k

total: $52k

If there are grandchildren, they can be included...

seattlecyclone

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Re: minimizing taxes on 401k inheritance
« Reply #5 on: November 19, 2013, 04:05:29 PM »
I believe Undecided was talking about what happens if you give more than $13k to an individual in a year. If you do that, gift taxes can potentially come into play, but there's a combined lifetime exemption from the estate/gift tax. So if, for example, you give your child a $1 million gift tomorrow, that will cause your estate tax exemption to go down by $1 million when you eventually die.

Abe

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Re: minimizing taxes on 401k inheritance
« Reply #6 on: November 19, 2013, 06:46:23 PM »
Thanks for all your help! They are all good ideas, we'll probably need to use all of them.

aj_yooper

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Re: minimizing taxes on 401k inheritance
« Reply #7 on: November 19, 2013, 08:20:33 PM »
As noted, your parents could also fund 529 funds for grandchildren (which grow tax deferred and can be funded to a significant amount).  Not sure re this, but if the 401k has a lot, they might be able to do a generation skipping inheritance for any grandchildren. 

While one of your parents is  working part-time, they could shelter that employment income and draw down a 401k, assuming both of your parents have them.  If they don't need the income, they should consider delaying Social Security until age 70 and taking 401k distributions in lieu of SS retirement.  This site has ideas on how to minimize taxes in retirement:  http://www.socialsecuritysolutions.com/social-security-knowledge-center.php

I would say they need to find a retirement finance planner/accountant/estate attorney to define what are their best choices, especially if there is a big stash.

Mr. Sharma

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Re: minimizing taxes on 401k inheritance
« Reply #8 on: November 19, 2013, 08:28:43 PM »
My understanding is that if I were to inherent the 401k, it would be taxed as income in my tax bracket (35%)? In this scenario, would it be better for them to withdraw the 401k, pay the marginal income tax at 25%, and give the cash as inheritance? Is there a way to transfer the inheritance to grand-children with lower tax burden?  Thank you for recommendations.

If you inherit a 401k/IRA, you do not have to take 100% of the distribution from the account immediately.  Depending on whether RMD's have begun or not for the original owners at the time you inherit, you have the option to (1) withdraw the balance within 5 years or (2) take RMD's based upon the beneficiary's life expectancy (the younger the beneficiary, the lower the RMD's).  This is the "stretch IRA" concept.  Naming grand-children as beneficiary's for IRA's is a common strategy to well, stretch out the distributions over a much longer term.  This allows for a much smaller amount of income to be distributed and taxed each year. 

In addition to some of the Federal gift/estate rules discussed, check with a local estate tax professional to advise you the inheritance/transfer/estate tax laws specific to your state.  They vary quite dramatically, NJ, NY & CA being the worst. 

CDP45

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Re: minimizing taxes on 401k inheritance
« Reply #9 on: November 19, 2013, 11:29:23 PM »
Can you receive more than 13k in gifts? Do all received gifts count towards gross income?

Undecided

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Re: minimizing taxes on 401k inheritance
« Reply #10 on: November 20, 2013, 08:21:26 AM »
Can you receive more than 13k in gifts? Do all received gifts count towards gross income?

Receipt of a gift isn't (federal) income. Gift tax is due (when applicable) from the gift giver, not the recipient.

CDP45

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Re: minimizing taxes on 401k inheritance
« Reply #11 on: November 20, 2013, 02:11:00 PM »
Sweet! I know a few people who are going to get this wiki page printed out for Christmas!!

http://en.wikipedia.org/wiki/Gift_tax_in_the_United_States

willn

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Re: minimizing taxes on 401k inheritance
« Reply #12 on: November 22, 2013, 10:27:55 AM »
14K per person per year for 2013 and 2014.  A couple can combine their exclusion for a total of 28K to one person per year.

http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/Frequently-Asked-Questions-on-Gift-Taxes#6

ender

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Re: minimizing taxes on 401k inheritance
« Reply #13 on: November 23, 2013, 08:00:45 AM »
Currently they can give $13K a year per person with no tax effect. 

They can also gift (while living) up to the current amount excluded from federal estate tax (albeit at the cost of decreasing the availability of that exclusion at death), without paying federal gift tax.

I suspect this is of the most unknown things about the way gifting money works.

So many families and such would probably be better off knowing this (rather than "I can only gift 13k a year per person!")...