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Estate: Your Questions Answered - Can You Stretch A 401K?

Aug 18, 2007
A reader recently asked if his 401(k) could be rolled over, by his beneficiary, to a 'stretch' IRA after his death. Read on to discover an answer that will protect your beneficiaries from tens of thousands of dollars in unnecessary taxes and keep your gift to them alive for generations to come.

Whether or not your beneficiary can rollover your 401(k) at your death (and subsequently stretch it) depends on who your beneficiary is and the terms associated with your company plan. Basically, you usually can't stretch a 401(k) account directly, but if that money is rolled into an IRA, you can. This is a situation where the details matter.

Let's assume for the sake of illustration that you have a wife and 3 children. If your spouse is the beneficiary, she can roll the money from your 401(k) to her own IRA. Assuming that she has named the 3 children as beneficiaries of her IRA, they would have the ability to stretch it at her death. ('Stretching' an IRA refers to the ability for a beneficiary to take distributions based on their life expectancy instead of all at once.)

Ideally, she would divide the money into 3 IRAs and name one child as the beneficiary for each one. That allows each child to stretch the IRA over their life expectancy. If the 3 children are the beneficiaries of 1 IRA then it would be stretched based on the oldest beneficiary's life expectancy.

On the other hand, if your children are the beneficiaries of your 401(k) plan they may or may not be able to stretch it. Let me explain. The tax laws allow for beneficiaries to stretch out distributions, but most company retirement plans do not permit it. The reason is simple--the stretch can take place over decades.

If the company allowed that, then they would be responsible for all the administration. There isn't any benefit to the company to do so while it exposes them to potential liability. Instead, most company plans will cash out the beneficiaries at the death of the employee. At best, the beneficiaries may be able to stretch it out over 5 years.

Realize what this means. Let's say you have $600,000 in your 401(k). If your wife is the beneficiary, she can roll it to her own IRA and then when she dies, the children can stretch it. If a child is in their 50's, that means that taxes can continue to be deferred (except for the annual required distribution) for almost 30 years. $200,000 can literally grow to millions of dollars over 30 years.

If those children were the beneficiaries of your 401(k) instead and were cashed out at your death, they would not have the ability to roll that money to an IRA. They would have to pay taxes on all of that money in the year it was distributed. In our example, each of your three children would have to claim $200,000 in ordinary income that year! This would bump each child's tax bracket and could result in 35% of it being lost in taxes. That's a tax bill of $70,000 each, or a total of $210,000 in taxes on your $600,000 nest egg.

Even if you have your wife as the primary beneficiary of your 401(k) and your children as the contingent beneficiaries, you are opening up the possibility of the children not being able to stretch distributions. If your wife passes away before you, or you both die in an accident, the 401(k) money would go to the children and most likely be distributed immediately.

There really aren't any benefits to keeping your retirement money in a 401(k) after you retire, but several big disadvantages. All of this is easily avoided by simply rolling that money to your own IRA. Your investment options will be much greater, and so will your flexibility and control.
About the Author
Nationally-syndicated financial columnist and Certified Financial Planner Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He will answer your financial question FREE at http://www.guardingyourwealth.net
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