Planning matters

Inheritance: Qualified Accounts

Inheritance can be a tricky topic both from the perspective of giving and receiving. Whether you are on the side of leaving an inheritance or receiving inheritance from a loved one, there are things to know before naming beneficiaries or cashing a check.

There are three typical types of assets left as inheritance:
• qualified accounts (tax deferred)
• non-qualified accounts (after-tax)
• real estate/land

Today we will be discussing qualified accounts. Keep an eye out for the follow-up blogs on non-qualified accounts and property inheritance.

Qualified Accounts

Traditionally, a qualified account is a retirement account funded with pre-tax dollars. Some common examples are 401k, 403b, 457 and Individual Retirement Account (IRA). When the owner of a qualified account passes away, the named beneficiary(ies) have rights to the account value. As taxes have not been paid yet, the individual inheriting the account will be responsible for the taxes upon distribution. The distribution requirements vary depending on the beneficiary’s relationship to the account holder. A few examples:

• Spousal Beneficiary: Spousal beneficiaries have the ability to either claim the account as their own, open and transfer the assets to an Inherited IRA or take a lump sum. If a spouse claims the account, all distributions will be based on their own age. If assets are moved to an Inherited IRA, distributions would begin either based on the deceased’s age or over a 5 year distribution period.

• Non-Spousal Beneficiary: A non-spousal beneficiary would need to open an inherited IRA and transfer the inherited assets into the account. The assets can be distributed to the beneficiary either over their own life expectancy, 5-years or in a lump sum.

• Charity: If a charity is named as a beneficiary, they will receive the account value as a lump sum. Also, charities receive the full amount tax-free.

*Note: Roth IRAs are qualified accounts and have similar distribution rules for beneficiaries, however the assets are tax-free at distribution.

As an account owner, think about who you’d like to benefit with what remains in your account at your passing. If you intend to leave your account to an individual, it may be a good idea to have a conversation with them about their future tax responsibility. If you are charitably-inclined, naming a charity or charities as beneficiary of your qualified account is a great option as the charity will receive the entire account value tax-free. If you’d like to take a look at your overall estate plan to make sure your assets are passed as you intend, set up a time to meet with your planner to discuss.

As a beneficiary, it’s important to understand how inheriting assets from a qualified account will impact your tax liability. Before taking distributions, talk with your financial planner or tax professional to create a tax efficient plan.

Written By Patricia Spies