Legal Issues Impacting Your Business
Children, parents, domestic partners can benefit in 2007
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New York, NY -- Inheriting a nest egg is about to get more lucrative because of a law that lets more people take over 401(k)s without a big tax hit.
Those who want to take advantage of the windfall through rules that kick in next year should proceed with caution, though, because a few special steps are necessary to get it right.
Until now, only a spouse could roll over 401(k) money from the account of a deceased person without paying taxes on it immediately. Under the new regime, a son or daughter, domestic partner or even a parent will be eligible for a similar tax benefit.
Enacted through a provision of the Pension Protection Act of 2006, passed in August, the law could raise the amount of money people save over the years, besides shielding them from taxes up front. It becomes effective at the beginning of 2007.
“Most people don’t realize the impact of it, the amount of money that can stay in a family,” said Ed Slott, a CPA and author of the book “Parlay Your IRA into a Family Fortune.”
Typical practice now is for a beneficiary who is not a spouse to cash out of a plan immediately and be taxed on the money. If the amount inherited is large enough, it can even mean a double whammy of taxes along with a bump up into a higher tax bracket.
A spouse, on the other hand, can roll the money into his or her own IRA and let it grow there tax-free until age 70 1/2.
To get the new tax break, a non-spouse beneficiary has to go through a critical extra step. An account known as an inherited IRA must be set up in the name of the deceased through a so-called trustee-to-trustee transfer.
For instance, after the death of John Doe Sr., an inherited IRA account would be set up in his name, and designated as being “for the benefit of” John Doe Jr., his son. This step would allow the trustee-to-trustee transfer that shelters the 401(k) transfer.
“It’s going to take a while for advisers and custodians to get their arms around this,” said Robert S. Keebler, a partner at Virchow Krause & Company, a law firm in Green Bay, Wis.
To set up the new IRA, beneficiaries can rely on an adviser or do it themselves, Justin Ransome, a partner in the Washington, D.C., national tax office of Grant Thornton LLP, an accounting and tax-advisory firm, said a beneficiary may need to send a letter to the former employer of the deceased, along with a death certificate, instructing it to issue a check in the name of the institution that will be the new trustee of the account.
“If the check is issued directly to you, you won’t be able to take advantage of the tax deferral,” Ransome said.
